Maybe you’ve heard of commuted value, redemption value, or surrender value, but you’re not entirely sure what each of these terms is and how it affects your life insurance policy. Essentially all of these terms are synonyms, including the term ‘cash value.’ These are all ways to discuss the equity you’ve built in your permanent life insurance policy, and it is also what you receive if you surrender your policy. Read on to learn what the cash surrender value of life insurance is, how to calculate it, and if surrendering is the right choice for you.
The cash surrender value is the money your insurance company will pay you if you voluntarily surrender (or end) your permanent life insurance policy. You can also think of cash surrender value as the present value of your paid-up insurance in whole life insurance and the accumulated cash value minus surrender charges in a universal life insurance product. The value of your cash surrender can be different from the total cash value in the policy in a universal life insurance policy, depending on the age of the policy and the cost of the surrender fees associated with universal life insurance.
Surrendering your life insurance policy means that you forfeit the death benefit, but you won’t have to pay any more premiums. This process is different from borrowing against your policy. Borrowing against your policy involves your cash value, but it keeps the policy and death benefit in place.
When you buy a permanent life insurance policy, most policies include the opportunity to develop cash value. In whole life insurance, your premiums go to purchase the death benefit after a nominal annual fee is paid to the insurance company, typically under $100 per year. Premiums paid toward a universal life insurance product pay a fee to the insurance company first. This fee is a percentage of the premium you pay and therefore is higher the more your premium is. After this fee is satisfied in universal life insurance products, the cost of insurance will be deducted from your premium, and what is left after fees and the cost of insurance will become your accumulated cash value. So each time you pay a premium, if the premium is large enough, you’ll accumulate more cash value. If there comes a point when you choose to surrender your policy, then your insurance company will return the cash value to you in a whole life policy or universal policy. They will subtract the surrender fees from your accumulated cash values and pay you the difference. Cash value returned to you is different from a viatical settlement, a life settlement, or extra value received from an accelerated benefit rider.
Many wonder if it’s correct to use the terms ‘cash value’ and ‘cash surrender value’ interchangeably. These terms are essentially synonymous, but there is one instance when they’re not. Most universal life insurance policies include a period of time called the ‘surrender period’ where you’ll be charged surrender fees if you terminate your policy. These surrender periods are often 10 to 15 years in length, but some can be shorter in policies issued earlier.
If you surrender your policy during the surrender period of a universal life insurance policy, the insurance company will take your cash value and deduct the surrender fees established in the universal life insurance contract. These fees can be quite expensive (especially if you surrender a policy in the first few years) but slowly decline over the surrender penalty time period of the contract. This situation is where the surrender value of a universal life insurance policy won’t equal accumulated cash value. In whole life insurance contracts, the cash value and the surrender value are equal from day one. Only policy loans or interest owed on a policy will reduce the cash value of a whole life insurance policy.
There are several factors that go into determining your cash surrender value. These are some of the most important factors that can help you calculate your value:
Once you take fees, time of ownership, type of policy, and premiums into account, you’ll have a better idea of your potential surrender value. Essentially, if you know how much cash value you have, you can subtract any surrender fees or policy loan interest and balance, and that will be your surrender value.
Life insurance has preferred tax treatment when it comes to withdrawing money. This is called FIFO (first in first out). This means cash surrender value can be withdrawn tax-free up to the cost basis of the policy (amount of premiums paid into the policy), before having to start paying tax on the growth. For example, if you paid $20,000 into a whole life insurance policy, you could withdraw (surrender) $20,000 from your cash value tax-free because you’d have paid that much in premiums already.
People choose to surrender their life insurance policies for a variety of reasons. One major reason is to have money to use in retirement when a death benefit might not be so critical. Another reason is to stop the premium payments. When these situations occur, you might consider surrendering your policy. But is it worth it in the long run?
The answer depends on the type of life insurance policy you have. If you have universal insurance, you might not accumulate much cash value over time because of the way the policy is designed. You could be paying large premiums to get little money back out of it. But if you have whole life insurance, keeping your policy can serve you in the long run—even during retirement. Whole life insurance guarantees cash value, which means you’ll always be accumulating more over time. This cash value can then be used to help with retirement or other expenses. A well-designed whole life insurance policy can provide more options and value than merely surrendering it. Whole life insurance can be used for passive income, or it can be rolled into an annuity to provide a guaranteed income for you for the rest of your life.
Even if premiums are costly or retirement is nearing, surrendering a policy isn’t the only option you have:
Ultimately, if you aren’t sure what the best solution is to your life insurance questions, we can help. Here at Life Benefits, we provide free strategy sessions where we can help answer your financial questions and guide you through the process of using life insurance to your advantage, including cash surrender value questions. Schedule a strategy session today, and we’ll help you get started.