Life Insurance Cash Surrender Value – How Does It Work?

Life insurance originally started out by providing peace of mind and financial security for surviving spouses or children. One of the less discussed parts is the life insurance cash surrender value. Since not everyone keeps their life insurance for life, this feature can make canceling the policy less painful in that you get some cash back when taking the right steps.

In this article, we’ll explore the cash surrender value, including what it is, why it’s important, and other options that might get you even more money if you decide you no longer need your life insurance.

Definition of Cash Surrender Value in Life Insurance Coverage

The cash surrender value on your life insurance policy is the money you will receive from the insurance company if you decide to terminate your policy before it matures. It’s one of the advantages of permanent life insurance contracts.

Not every policy has this. You have to hold a permanent life insurance policy. Term policies never have this feature.

Cash surrender value offers flexibility if financial circumstances change over the course of the decades that someone might hold their insurance policy. You can get some cash out of the policy if you no longer need it. Depending on the structure of your policy, it could also be used to pay premiums or even used as a loan.

One more key point. There are tax implications for surrendering your life insurance policy for cash. If you’re getting more money out than you paid in premiums, the excess amount will be considered taxable income on tax day. Discuss the implications with your accountant so you aren’t hit with any tax surprise.

Understanding Cash Surrender Value

The cash surrender value is based roughly on your cash value accumulation, which builds up as you pay your premiums. 

Several other factors weigh in on how much you’ll get from surrendering your life insurance, such as:

• How long you’ve held the policy
• Premiums paid
• Administrative charges from the insurance company
• Surrender fees
• Policy growth
• Outstanding policy loans

Before committing to surrendering your life insurance, it may be financially worthwhile to consider other options, such as selling it for cash through a life settlement.

How is Cash Surrender Value Calculated? 

Most companies start with the total accumulated cash value minus the cost of insurance, policy administration charges, and any outstanding policy loans.

It can vary widely depending on your insurance company. There are sometimes penalties as well. These penalties come in the form of surrender fees. But if you’ve held the policy for at least ten years, the fees should be negligible, if there are any at all.

Here’s what you need to know about canceling life insurance with cash value.

The longer you hold the policy, the more premiums you’ve paid over the years, and the larger your cash surrender value becomes.

Why Consider Cash Surrender Value When Purchasing a Policy

Most people don’t even think about the cash surrender value of life insurance when comparing life insurance policies. They might look at the cash value accumulation, and we highly recommend that for some strategies – especially if you’re considering using your life insurance as a tax-free retirement income stream.

But since the cash surrender amount is just the cash value accumulation minus the fees and factors above, let’s take a quick look at the advantages.

• Allows use of cash value via policy loans for anything from a child’s education to a dream vacation
• Use it to pay premiums if cash is tight
• Fund a tax-free retirement income stream
• Switch to a paid-up policy – eliminating future premiums

However, considering this aspect, it does add an element of liquidity to your life insurance, which can help during financial hardship. However, we’d recommend taking loans against your cash value first unless you no longer need the policy.

Types of Permanent Life Insurance Policies that Accumulate Cash Value 

Most permanent life insurance policies have some type of cash value component. The most common types of cash value life insurance policy are: 

• Whole Life Insurance: focused on the death benefit and grows cash value slowly, sometimes at a guaranteed rate.
• Variable Universal Life Insurance: allows you to invest your cash value. It can grow faster than a whole life policy, but you risk losing it all if your investments do poorly.
• Indexed Universal Life Insurance: Your cash value growth is tied to an index (like the S&P 500) but also has a floor, so you can’t lose any money on a bad year. Generally, IUL is a better option for cash value focused life insurance than the other two.

Whichever type of life insurance you purchased affects your current cash surrender value. If you are getting rid of the policy and keeping the option open of replacing it in the future, it may be worth considering which type of permanent insurance best meets your new financial goals when the time comes.

The Difference Between Term and Permanent Life Insurance Policies 

While permanent life insurance has varying levels of cash value accumulation, term life insurance does not. Permanent life insurance lasts for your entire life, at least for most people. If you look carefully, there may be what’s called a maturity date. That’s when the policy matures, and you get the benefits while still alive. However, keep in mind this can come with a large tax bill, too. Most permanent insurance policies have maturity dates at one of the following:

• Age 95
• Age 100
• Age 105
• Age 121

Term life insurance policies provide death benefit protection for a set number of years. Because it expires and there’s no cash value balance, that often lets companies offer term insurance at 1/10th the price of a similar permanent policy.

Cash Value – What Does It Do?

Part of your premium payment goes toward the cash value of the policy, which makes up your cash surrender value. This component also allows you to borrow against the death benefit on your policy—basically, a no-questions-asked loan with the death benefit as collateral. We’ve seen everything from people using their cash value instead of a car loan to partially funding their retirement tax-free.

How The Cash Value Grows Over Time

Cash value growth is where the type of permanent policy comes into play.

Whole life policies grow based on dividends declared by the insurance company.

Variable universal life policies allow you to invest your cash value directly into the market. You can lose money here. It’s something that we don’t generally recommend.

Indexed universal life insurance grows tied to an external index. So if the S&P 500 has 10.3% growth for the year, the insurance company credits your cash value 10.3% growth. If the index drops 29%, the floor on this type of policy will grow your cash value at 0%.

The whole point is to avoid losing money so you don’t spend years making up the losses. It’s a good option if you want to build up a significant amount of money in a life insurance contract.

What Are Surrender Fees & Charges 

Surrender fees (also called surrender charges) are what you pay if you want your cash surrender value within a specific time period after taking out the policy, usually the first ten years. You’ll see it written as the surrender period in your policy contract. It outlines how much money you’re getting percentage-wise of your cash value account. As always, it varies widely depending on the life insurance company.

On average, you can expect the cash surrender fee to start at 10% of the cash value and then decline by 1% each year until it hits 0%.

Next Steps If You Want Your Life Insurance Policy’s Cash Value 

Contacting your insurance company can tell you what your current cash surrender value is. If they have an online account management system, there should be an option there as well.

However, comparing all of your options is a good idea, too. Instead of surrendering your life insurance, you can often get more if you sell the policy to a third party. The short version is they will become the policy owner, take over the premium payments, and receive the death benefit when you pass away (hopefully a long time from now.)

To see what you could get for your insurance policy (and compare that to your cash surrender value), use the box below or at the top of this page.

Click here to read more about selling your life insurance for more than the cash surrender value.

You can also call our team at (858) 703-6178 anytime. We’ve helped many families successfully sell their policies for more than the cash value amount and use the cash to build a better financial future.