Should I Surrender My Life Insurance Policy?

The image shows a senior couple eating at their home.

How much cash is your policy worth?

It’s estimated that a standard life $500,000 cash value life insurance policy can cost up to $20,000 a year to keep in force.

While keeping a life insurance policy active can be a good life decision for many, for others monthly policy premiums may prove to be too big a financial burden.

In these cases when you are unable to pay to keep your life policy active, or you no longer want to, you have the option to cancel your policy through a process known as a “surrender.” This allows you to discontinue your policy with your insurer in exchange for a specified amount of money known as the “cash surrender value.”

While canceling a policy may make sense for your particular financial situation, you’ll want to first make sure you understand what’s entailed in surrendering a policy, and what your options are, in order to make the most informed decision.

Reasons to surrender a life insurance policy

The most simple reason to surrender a life insurance policy is your need for immediate cash exceeds the needs of your beneficiaries after your death. There are a few common instances where this is the case.

1. Risk of policy lapsing

When you can no longer afford to make premium payments on your life insurance policy, it will become inactive, or ‘lapsed’. This happens to roughly 4.2% of policies each year, and leaves policyholders with no value to show for their years of premium payments.

Rather than have a policy lapse and leave you with nothing, many policyholders choose to either surrender their life insurance policy for cash, or sell it in a life settlement.

Policy lapsing is particularly problematic to those with term life insurance policies. Policies with a cash value component, such as whole life insurance policies, may continue to draw down premiums from the cash component, rather than go inactive.

2. Beneficiaries no longer need it

As policyholders grow older, many face the unfortunate circumstance of losing their loved ones.

If your spouse or primary beneficiary is no longer in the picture, there may no longer be a need for life insurance coverage, as there is no longer an intended beneficiary.

In these circumstances, a policyholder can choose to cash in or surrender their life insurance policy to take advantage of the value stored inside rather than let it go to waste.

3. Accessing the policies cash value

If you have a permanent life insurance policy — such as whole or universal life insurance — then there is a cash value component built into the policy.

Depending on the face value years of the policy, these cash value components may be worth tens or even hundreds of thousands of dollars, which can be critical sources of funds if you need to pay large expenses such as medical bills. Surrendering your life insurance policy allows you to access this cash surrender value.

If you have cash value life insurance, surrendering is not your only option. You may also consider a policy loan, which allows you to borrow against the value of your policy, or exercise cash value withdrawals, which accesses some of the policy’s accrued value while still keeping the death benefit active.

If you have term life insurance, then there is no cash surrender value. If you are looking to maximize your cash from surrendering a term life policy, we recommend a life settlement.

4. Getting a new policy

There are a number of reasons you may want to get a new policy and surrender your old one. These reasons include:

  • You are in substantially better health and are able to get a better rate
  • You are able to find better coverage with another company
  • You have had a bad experience with your insurance agent, company, or both
  • You’d like to change the type of policy you have

In the event your reason for surrendering a policy is to take out a new one, you may want to look into the option of converting your old policy into a new one with a 1035 exchange.

How much is my cash surrender value?

The cash surrender value of your policy will depend on the type of policy, the number of years you’ve had it, and how much you’ve paid in the amount of premiums. In general, it will be slightly less than the cash value of the policy.

A senior couple using their life settlement money to enjoy an expensive meal out.

Generally speaking, cashing in a life insurance policy will yield you a net loss of money, meaning the amount of your surrender value is less than the total you paid in premiums. This is likely to be the case until the policy has been held for at least 20 years.

Additionally, there are a few circumstances that might decrease the total amount you receive when surrendering your life insurance policy. We outline them below.

Surrender fees

If you cancel a policy in under 10 years from its origination date, it’s likely you will face early surrender charges and fees. These are put in place by life insurance companies to cover their bottom line, as they are offering your policy the expectation that premium payments will be made long term.

Surrender charges tend to decline over time. For instance, a typical schedule may require you to pay 10% for canceling a policy in the first year, and pay 1% less each year after that. After the tenth year, you exit the surrender period and no longer owe any early surrender fees.

Outstanding loan balance

If you exercised a policy loan while your policy was still active and did not repay the full amount, any outstanding amount (including amounts from the loan’s interest rate) will be deducted from the amount of cash value you receive.

Taxes

For the most part, your cash surrender value will be tax-free. When you will start to incur income tax is when the cash value of your policy exceeds the amount you paid in premiums. This excess amount comes from the value your policy accrued by investing your savings, the difference between your total cash proceeds, and the amount paid in premiums will be taxed as ordinary income.

How to surrender a life insurance policy

If you want to surrender your life insurance policy, the steps are very simple and follow the same procedure where you have a term, whole, or universal life insurance policy.

  1. Contact the insurance company and ask for a surrender form. These can be sent in the mail or found on the insurance company’s website.
  2. Complete the surrender form as specified or write a letter of instruction and mail it to the insurance company (we recommend paying for tracking).
  3. Confirm with the insurance company your letter was received and that you don’t need to pay anymore.
  4. Receive your policy’s cash surrender value, either as a lump sum or as an annuity.

A life insurance company cannot refuse your desire to surrender a policy, and doing so will not hurt your credit score. However, we again highlight there may be potential surrender fees and taxes you to pay for early cancellation of a policy. 

What about a life settlement?

If you are set on canceling your life policy and want to maximize your payout, a life settlement can get you much more than a cash surrender.

A life settlement is an agreement between a policy owner to sell the rights to their policy’s death benefit in exchange for a lump-sum payment. A life settlement transaction is completed with a third-party investor, often referred to as a life settlement company (which is different from a life insurance company, which underwrites your policy itself). Life settlements can be done with any type of cash value insurance product and also some term products.

What's your life insurance policy worth?

According to the Life Insurance Settlement Association (LISA), the total amount from a life settlement will “always be greater than the cash surrender value and less than the death benefit value.” The exact amount will differ based on the type of policy, the value of the policy, and the life expectancy of the insured individual as determined by the settlement company’s underwriting department.

Individuals who face terminal or chronic illness can execute a particularly high-paying type of life settlement, known as a viatical settlement.

Please note: If you have a term life insurance policy, a life settlement will always net you more money than surrendering the policy or simply letting it lapse.

Get a free valuation of your life insurance policy

While this article has highlighted the essentials of when, why, and how to surrender a life insurance policy, we still strongly recommend speaking with a financial advisor before making a decision. There are tax consequences of selling your policy, regardless of the type of life insurance you own.

Most importantly, we wish to emphasize the difference between the desire to no longer pay for a policy and the decision to surrender it for its cash value. There’s more than one way to cash in on a life insurance policy, and the insurance payout for surrendering a policy for cash tends to be the least effective on a payout-to-cost basis.

How much could you sell your life insurance policy for? Find out in seconds with our free life settlement calculator.

Author:
Chris Granwehr is the Founder of Dawn Life Settlements and a former senior manager with Mason Finance, an industry-leading life settlement provider in California. He's a member of the Life Insurance Settlement Association, and he has a passion for empowering customers financially through a faster, easier life settlement system.