What Is the Difference Between Cash Value and Surrender Value?
Determining whether to utilize your life insurance policy’s cash value or surrender value only comes into play if you cancel and cash out your policy while you are still alive. Unlike term life plans, permanent life insurance policies offer lifetime coverage and a cash value component, which enables a portion of your premium payments to go toward growing your plan’s cash value.
Should you decide to terminate coverage at any time, you will receive the cash surrender value, not the full cash value of your policy. Your insurance company may charge a steep fee and would subtract any outstanding policy loans from the death benefit to calculate the surrender value. The age of your policy significantly impacts the surrender fee.
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Can Life Insurance Be An Investment Vehicle?
Yes, you can leverage the cash value of your life insurance policy as an investment, though this is not its primary purpose. Any permanent life insurance policy with a cash value option allows policyholders to invest a portion of their premiums toward an increased death benefit, often at fixed minimum growth rates.
Some types of permanent life insurance, such as variable whole life policies, enable policyholders to invest their cash value in stocks, bonds, and mutual funds. Enrolling in whole life insurance as an investment can help those with poor money-saving skills accrue funds; however, they may potentially only see small, gradual gains at first.
A Closer at Cash Value
Accumulating cash value may only occur in permanent life insurance policies, such as a standard universal life policy or a whole life policy. As you pay your premiums for your life insurance, part of that premium gets allocated to the cost of insurance, management fees, and the cash value of the policy.
There are three main types of permanent life insurance:
- Traditional Whole Life Insurance: Premiums for whole life policyholders will stay level, meaning they will never go up as you get older. The cash value in the whole life policy grows based on a mathematical formula that the insurer determines and may limit how much control you have of the cash value.
- Universal Life Insurance: Universal life policies allow for flexible premiums in which you may change the death benefit and premiums of your policy at any time. In a universal life policy, cash value grows based on the economy’s current interest rates. As the insured, you have more control over how much the cash value grows.
- Variable Life Insurance: Variable life insurance is a hybrid between traditional and standard universal life insurance. The cash value in variable life insurance allows you to have more control over how it’s being invested through stocks, bonds, and mutual funds.
The cash value in your policy may be considered a living benefit, which allows you to access the features of your life insurance while you’re still alive. Bear in mind, the cash value in your policy is separate from your death benefit, which means that when you pass, your beneficiaries do not get access to your cash value.
With cash value, you may:
- Pay premiums with cash value
- Withdraw your cash value at any time while your policy is active, tax-free
- Take out a loan against your cash value without it affecting your credit score
A Closer Look at Surrender Value
The surrender value may only occur on permanent life insurance policies. In the case that you choose to partially or fully cash out your life insurance policy, you may receive a surrender value from your policy.
Partially surrendering your life insurance policy is also an option. This may lower the cash value, but it allows you to withdraw cash without terminating your life insurance policy all at once. In comparison, a full surrender of your life insurance may lead you to cancel your life insurance altogether. In doing so, you may receive the cash surrender value that has accumulated over time.
When surrendering your life insurance policy, you may incur surrender fees. A surrender period could last from 5-to-10 years and fees could be higher in the earlier years of your policy.
There are many reasons why the insured would choose to partially or fully surrender their life insurance policy. For example, if you switched jobs and your new job offers you a better rate for life insurance, you may take that offer instead.
Although surrender value is related to cash value, it is not the same thing. The difference is that the cash value shows the overall accumulation of your interest and cash. The surrender value is the amount the policyholder could receive after surrender charges have occurred.
At a Glance: Cash Value vs. Surrender Value
Term or Permanent
Type of Permanent Policy Applicable To
Whole lifeUniversal life
Whole lifeUniversal life
Average Surrender Fee
10%-35% of cash value
10%-35% of cash value
Can Be Withdrawn During Surrender Period?
Access to Full Amount?
Considered Taxable Income?
Can Be Borrowed Against?
Comparing Your Options
Enrolling in a life insurance plan with a cash value option can allow policyholders to grow their net worth, leave more of a legacy to their beneficiaries, and save for their retirement. Cashing in on the surrender value of your policy may better serve your needs if an unexpected expense or significant life change occurs.
Accessing Your Funds
A permanent life insurance policy left undisturbed to build cash value over time and accumulate interest can significantly impact the death benefit amount. While this may be the ideal scenario for leaving extra funds to your beneficiaries, another benefit of the cash value option is its availability for withdrawals or loans, as needed.
If you decide to cancel coverage and cash out, however, you can actually only access a portion of your cash value amount, depending on the age of your account and its balance. Insurers charge penalties according to the structured fee schedule below. Most abide by the “seven-year rule,” which lowers or eliminates the surrender fee for older policies.
Surrender Period of Life Insurance Policy
1 to 3 years
4 to 5 years
Permanent life insurance policies with a cash value component hold any gains you earn on top of the death benefit, tax free. You do not owe taxes on the cash value or any accrued interest, as it is distributed tax-free to your beneficiaries when you pass away.
However, the cash surrender value may include some tax implications. The premiums you pay into the policy make up the “cash basis” or principal, which is returned to you tax free if you surrender the policy. Any amount you earn in cash value over the principal is taxed.
In addition to cash value gains, taxable earnings may include policy loan interest and withdrawals that exceed the cash basis amount. Some policies impose additional tax penalties for withdrawing funds, depending on the age of your account.
Any whole or universal life insurance policy with a cash value also features loan options. You can take out a policy loan using your cash value as collateral, but only after accumulating enough cash value, which typically takes several years. You must pay back the loan or subtract the loan amount from the payout your beneficiaries receive.
Unpaid policy loans reduce the amount of your death benefit, lowering the cash surrender value since the surrender value is only a percentage of the full cash value. You may be subject to paying taxes on the outstanding interest of a loan if you surrender your policy.
Surrender charges occur when a policyholder cancels their life insurance coverage. Surrender charges cover the costs fronted by the insurer to provide your benefits, especially the commissions for insurance sales agents, who get paid upfront.
Surrender charges tend to decrease as your policy ages. Most insurers require a 10% surrender charge during the first 1-3 years but gradually lower the charge to as little as 0% by the 7th year of enrollment. Insurers sometimes waive the surrender charge for policyholders who notify them in advance of their plans to cancel coverage.
Which Option Should You Choose?
Choosing a policy for its cash value vs. surrender value can be tricky. Consider your long term investing and coverage goals to make the right decision for your lifestyle.
Choose Cash Value If…
You may be suited to choose a permanent life insurance policy based on its cash value potential if you can spend multiple years growing your earnings. Since most policies take at least a few years for premium payments to increase the cash value, this option works best for mid life policyholders enrolled for the long term.
You can choose how to invest and diversify your portfolio through the cash value option. Some plans offer riskier investments tied to stocks, bonds, and mutual funds but with potentially higher gains than conservative policies. You may choose to grow your cash value and leave more of a death benefit behind or borrow against the cash value.
Choose Surrender Value If…
The ideal candidate to choose cash surrender value has kept their policy for seven years or more, has no outstanding policy loans or interest, and can risk losing the protection of life insurance coverage. The goal is to maximize the cash value while minimizing surrender penalties and charges.
Remember that the cash surrender value is always inherently less than the death benefit. Since most individuals would need years to grow their cash value and reduce their surrender fee, choosing a policy for its surrender value is not the most timely option. Instead, they might explore traditional investing options and term life insurance.
Whole and universal life insurance policies with cash value and surrender options offer advantages beyond basic life insurance coverage. If necessary, policyholders can save more toward their death benefit or surrender coverage and cash out.
- Grows the death benefit awarded to your beneficiaries when you pass away
- Cash value is permanent and lasts for a lifetime as long as premiums are paid
- Acts as a tax-free savings account for retirement expenses
- Enables worry-free saving practices (a portion of the premium payments automatically goes toward the cash value)
- Can help diversify your financial portfolio
- Can incorporate a variety of stocks, bonds, and mutual funds
- Funds may be used to pay premiums once the policyholder reaches a certain age
- May include minimum, fixed cash value growth rates
- Can be borrowed against for a tax-free policy loan with lower interest rates than traditional lenders
- A feature of any permanent life insurance policy with a cash value option
- Can offer financial assistance in a lump sum for major expenses
- Favors long standing accounts through decreasing surrender fee schedules
- Returns to policyholders the amount of premiums paid into their policy, tax free
- No longer requires monthly premium payments, account is “paid up”
Focusing on a permanent life insurance policy’s cash value or surrender value can come with some disadvantages. Consider how the following cons might affect your ability to grow your policy’s cash value.
- Premiums tend to be more expensive for this type of policy than term life
- Your account may accrue interest over time and require other costly fees
- This may require more frequent micromanaging of savings allocations and dividends
- Tend to be highly complex compared to term life insurance policies
- Require a higher cost (premium payments) than other tax-deferred investment/savings vehicles
- Often includes prohibitive fees, especially for accounts less than three years old
- Returns only a portion of the cash value of the policy
- Requires canceling of life insurance benefits, leaving individuals unprotected
- Deducts any outstanding loans and fees from the cash surrender value
- Surrenderers can be taxed for unpaid interest on policy loans
- Any gains in cash value (if more than the returned premium payments) are also taxable as ordinary income in the surrenderer’s usual tax bracket
Putting It All Together
The issue of utilizing the cash or surrender value of your policy depends on several distinct criteria, including the policy’s age, coverage needs, and financial needs and goals. The cash value component is among the most popular features of a permanent life insurance plan, enabling policyholders to earn savings to add to their death benefit.
Any permanent life insurance plan with a cash value component also inherently includes a surrender option, which allows policyholders to cancel coverage and “cash out.” The surrender value includes a return-on-principle of premium payments to date but also deducts any policy loans and surrender fees before issuing the remaining payout.