Navigating the Decision: Canceling Life Insurance with Cash Value

Life insurance is a cornerstone of a family’s financial safety net for many people. But as life situations change, sometimes it’s no longer needed. With term insurance, canceling your policy is as easy as telling your agent you want to cancel, and then you stop paying premiums. For canceling life insurance with cash value, that route would likely leave any money you might get back in the hands of your insurer.

Instead, there are a few ways to get as much as possible back from a cash value policy.

Quick Takeaways

• You can get some of your cash value back when you inform your insurance company that you’re canceling your policy
• There are often surrender fees to be aware of
• Check with your tax professional or accountant to see what taxes you might owe on the received cash value
• If you just stop paying, you won’t get anything back
• You can sometimes get more for a policy by selling it to a third party than you can by canceling

But first, why is your cash surrender value important?

Explanation of Life Insurance with Cash Value

Cash value typically builds up in permanent life insurance, such as a whole life insurance policy, universal life, or variable life. It’s more than providing a death benefit to your family. The cash value component lets you make use of your life insurance while you’re alive.

It typically builds up over time as you pay your premiums. Then, you can take policy loans, use it to pay premiums, or even boost the value if you choose to sell your policy rather than cancel it. The best part is that it grows tax-deferred or tax-free, depending on whether you withdraw it or use a policy loan (which you never have to repay.)

If you’re curious about other uses of a cash-value life insurance policy, read our article on how indexed universal life insurance can create a tax-free income stream.

Reasons for Canceling Life Insurance with Cash Value

Canceling life insurance with cash value is not an easy decision. It can be hard to weigh the immediate need for financial security with the different ways a financial future could play out.

Most of the time, we speak with people who don’t know what else to do when they find themselves in one of the following situations:

Need the accumulated cash for financial emergencies. Medical emergencies and subsequent bills can be enough to push most families into financial strain. A policy’s cash value can help ease or eliminate the debt. However, talk with your agent about a policy loan against the cash value. It could make more financial sense.

Want a type of life insurance with better performance. A cash-value-focused IUL has better growth than a whole life policy, for example.

No longer need the policy. The mortgage is paid off. The kids finished college. Those are two of the big reasons for purchasing life insurance in the first place.

Have different insurance needs. Perhaps the death benefit is no longer important to you. Or you want a policy with a long-term care rider to address that risk of aging. Some policies let you change it while it’s active. Before canceling, discuss your specific needs and risk tolerances with an agent.

The policy no longer aligns with your financial goals. Variable universal life policies used to be incredibly popular decades ago. But we’ve found that over the years, they don’t have the downside protection that indexed universal life policies have. They can also become increasingly expensive due to the cost of insurance as you get older. It may make sense to switch to a different policy, but have your agent run the numbers first to see what lower premiums might look like. 

Struggling to afford the premiums right now. Job insecurity can mean cutbacks on household expenses, with life insurance being one considered after someone loses a job. It might be the right decision, but there are other ways to use your cash value to keep the policy in force if you want to keep it or use the cash value to dig yourself out of a financial hole.

The surrender fees are another major thing to consider before canceling a life insurance policy.

Understanding Surrender Fees: A Key To Making an Informed Decision

Insurance companies attach surrender fees to life insurance policies with cash value. It’s meant as a deterrent for trying to cash out the policy early – either before the insured passes away or the policy’s maturity date. The surrender fee can drastically reduce the cash you get when canceling life insurance with cash value.

They are meant to compensate the insurer for administrative costs, lost premium payments, and the risk they took on for the insurance.

How Surrender Fees are Calculated

Surrender fees vary widely between life insurance companies. You’ll need to read through your life insurance contract to determine exactly what yours will be.

In general, surrender fees are highest in the early years of a policy. Then, they stair-step downward the longer you hold it. Many companies eventually reduce the surrender fee to 0% after 10 to 20 years (this will vary by policy.)

Most of the time, the surrender fee is a percentage of your policy’s cash value. It usually starts around 10% and then drops about 1% a year for ten years until it finally hits 0%. (Unfortunately, it doesn’t drop below zero, where they pay you to surrender your policy. But we’ll outline other methods for getting paid to give up your policy in the alternatives section below.)

Impact of a Surrender Charge on Accumulated Cash Value

Let’s say you’ve built up $40,000 of cash value in your life insurance policy that you want to cancel, and you’ve held the policy for five years. If you’re paying a 5% surrender fee, that becomes $38,000, which sounds much better before you calculate what you’ll pay in income taxes. 

Withdrawing the cash value of your life insurance typically means it’ll be taxed as ordinary income, both at the state and federal levels. Policy loans and death benefits are tax-free. Always double-check the tax implications for your location with a financial professional.

Other Options for Canceling a Life Insurance Policy

Before deciding that canceling your life insurance is the right option, there may be a better option to what you’re facing – or at least get you more money for your current policy.

Sell Your Policy via a Life Settlement

A life settlement is when you sell your life insurance policy to a third-party investor. You typically get more than the cash value of your policy but less than the death benefit.

If you no longer need the coverage or the life insurance premiums don’t make sense in your household budget, selling the policy can bring in more cash than canceling it.

Buyers typically require:

• A death benefit of at least $100,000
• A permanent life insurance policy, such as whole life or IUL
• The insured must be at least 65 years old

There is some wiggle room here if you don’t quite meet the requirements. Sometimes a term policy has a conversion option, which you can use to turn it into a permanent type of policy. Give us a call at (858) 703-6178 today or read our complete guide to life settlements.

What is your Life Insurance Policy Worth?

Use Your Cash Value to Purchase a Paid-Up Policy

If you want to keep your life insurance policy but the monthly premium is becoming troublesome, you can try converting the cash value to a “paid-up” policy, sometimes called a reduced paid-up option.

You’ll lose most or all of the cash value of the policy. But it’ll let you skip paying premiums for the rest of your life. It’s a reasonable trade in many situations. However, expect a lower death benefit than your current one.

It’s a good way to compromise between keeping coverage for either your family’s protection or leaving something for your heirs and keeping your financial house in order.

Next Steps

Canceling life insurance with cash value can be the right answer. But if you would rather get more for your policy via a life settlement, our team is here to help get you the most cash for your policy. Give us a call today at (858) 703-6178.