Permanent life insurance is an excellent investment for you and your loved ones. But what happens if policyholders want to take their money back or if they don’t need life insurance anymore?
When you invest in a life insurance plan, you should keep in mind the death benefits the policy comes with. You should also remember that the policy can be terminated voluntarily at any given time. Hence, policyholders should be aware of the cash surrender value. Also, if you are still looking for an adequate life insurance policy, make sure to check out our list of the best life insurance companies in the US.
What Is Cash Surrender Value?
When you view your life insurance contract, you are bound to notice the term cash surrender value in the policy. This term refers to the amount the policyholders will get if they want to retrieve their policy's cash value.
Commonly known as annuity surrender value if you work with annuities, or surrender value, this sum differs from the policy's cash value.
Let’s look at the difference between the policy’s cash value and surrender value:
- Cash value is the amount of money you have in your policy that earns interest over time due to premium payments.
- Surrender value is the amount of money that a policyholder gets when terminating or cashing out the policy.
A surrender value is lower than the policy’s cash value because of the surrender fees applied by insurance companies if a policyholder decides to withdraw money from the account. Keep in mind that because the surrender values are interlinked with your premium payments, the value may keep changing during your policy period.
Understanding Cash Surrender Value
If you have a whole life insurance policy, some parts of the premium payments you make every month will go to the death benefit. The remaining amount will go towards the cash value of your account.
The thing is, when you sign a contract with the life insurance provider, you agree to pay the premium for your policy period. In exchange, your carrier is responsible for paying the benefit if you die. In addition, the insurance account can also be seen as protection if you choose to terminate the contract with your provider.
If you decide to cancel the life insurance policy, you will be required to pay for any damages caused by the breach of contract. The surrender fees are deducted from the contributions made to the cash value of the account. As soon as the insurance company has deducted the money, the remaining amount (surrender value) will be paid out to the policyholder.
How Is Cash Surrender Value Determined?
In order to determine the cash surrender value of life insurance, you need to consider the following:
- The duration of your policy
- How much money you have paid the insurance company so far
- The kind of insurance policy you have
- Whether the insurance company has invested your premium payments
- The market performance for investment portions that are included in the policy
- Surrender fees
The easiest way to calculate the cash surrender value is to subtract any policy loan interests and balances or surrender fees from the cash value. In addition, you can always contact your insurance company to get an exact cash surrender value for your policy.
What Kinds of Life Insurance Have Cash Surrender Values?
Permanent life insurance policies allow cash surrender values. They include:
- Whole life insurance
- Universal life insurance
- Indexed universal life insurance
- Variable universal life insurance
These kinds of insurance policies have death benefits and a cash value that increases on a tax-deferred basis. Different types of life insurance policies accumulate cash value differently.
Keep in mind that you may pay higher expenses for a permanent life insurance policy during the first years of the policy. However, you must understand that in the future, you will be paying significantly less.
The cash value of the insurance can be used during the time you are alive. For example, you can use it to fund a new business, pay for your child's college tuition, or even buy a new home. In addition, most people use the cash value as a monthly income when they retire from work. These features allow permanent life insurance to work as a cash-building tool as well as an investment.
What Are Surrender Fees?
When you claim the cash surrender value of your life insurance policy, many companies will charge a surrender fee. These fees are pricier for newer policies, but they become less expensive over time. Depending on the duration and age of the policy and the plan you choose, surrender fees can vary vastly. Usually, surrender fees fall in the range of 10% to 35%.
Let's say you have an eleven-year-old life insurance policy that has a cash value of $6,000. You decide to surrender the policy for cash value. Once the insurance company adjusts their surrender fee of 20%, you will receive $4,800. The company will keep the remaining $1,200 as fees. The amount of money you get is the cash surrender value, while the initial payment of $6,000 is the base cash value.
Keep in mind that you can also be taxed on some percentage of the cash surrender value of life insurance. If you are not aware of the tax laws of your policy and the cash surrender value, it’s best to get in touch with your insurance company, accountant, or agent.
Cash Value vs. Surrender Value: What's the Difference?
Commonly referred to as account value, the cash value is the amount of money accumulated in the permanent life insurance policy or cash-value-generating annuity. Some of this money paid through premiums is allocated by your insurance provider toward investments. Then, the insurer credits your policy, depending on the investment performance.
According to the laws in the United States, a life insurance policy cannot be marketed as an investment vehicle. Yet, many policyholders use variable life insurance, whole life, or universal life policies to grow tax-advantaged retirement assets.
Note that term life insurance policies don’t form cash value.
On the other hand, surrender value is the amount of money a policyholder will get if they access the policy cash value. If you withdraw cash from the policy too early, a penalty will be applied.
In most cases, the main difference between your policy's surrender value and cash value is the charges that come with early termination. The insurance provider prefers if you continue paying premiums without asking for an early withdrawal of funds. Hence, when you cancel the policy, various costs and fees are applied to discourage you from your decision.
The surrender fees will cause the surrender value to drop. The policy's surrender value and costs can vary over the duration of a policy. However, after a certain amount of time, they will no longer be in effect. That’s when the surrender value and cash value will be the same.
Based on the policy you have, the way you access the cash surrender value varies. However, many companies require you to cancel the policy before giving you access to the funds. Even if that’s the case, you may take a loan out against your policy cash value.
Alternatives to Surrendering Your Policy
Before you surrender your life insurance policy, you must explore other options. Let’s look at a few alternatives:
- Withdraw Cash Value
Usually, you can make a direct withdrawal from the cash value. Even though you may have to leave a set amount in place, you can still withdraw and make use of the remaining amount.
However, remember that the money you choose to withdraw could be deducted from your death benefit. This means that your loved ones will be left with less money when you pass away.
- Take Out a Policy Loan
You can take out a policy loan if you want to get fast money from your life insurance policy. These loans use your life insurance policy as collateral.
If this loan is not paid off when you pass away, the insurance provider will automatically remove the owed amount from the death benefit.
- Sell the Policy
If you really want to cancel your policy, you should consider selling it instead. This could be more beneficial than the cash surrender value. This is known as a life settlement.
In Conclusion
Before canceling your permanent life insurance, check if you have another alternative in place. For example, it could be a term life policy.
Moreover, keep in mind that permanent life insurance is not just about a death benefit — it‘s also a chance to collect funds for your retirement.
If your needs are no longer the same, talk to an estate planner or financial advisor before changing anything in your insurance policy. They will explain how canceling a permanent life policy will affect you. You can also discuss associated fees, particularly if you have any outstanding dues.
If you are considering purchasing permanent life insurance, it’s best to talk to a financial advisor or accountant and lay out your financial goals and current situation. This will help you determine what policy best suits your needs and learn about the tax implications and benefits.
