Understanding Cash Surrender Value in Life Insurance
Permanent life insurance policies accumulate cash value over time. When you pay your premiums, the insurer sets aside a portion in an interest-earning account. The longer you pay premiums, the more the cash value grows. You can borrow or withdraw from the cash value.
The cash surrender value is the amount you get to keep minus fees when you surrender or cancel the policy. Keep in mind surrendering the policy leaves you uninsured.
Do not confuse a policy’s death benefit with its cash value. The death benefit is the amount your beneficiary receives when you die. The cash surrender value is the cash you get after canceling your policy.
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Your Changing Life Insurance Needs
Life changes can reduce your need for a life insurance policy. Children grow up and become independent. We pay off a house and downsize. A student is accepted to a dream school with higher tuition than planned. Maybe you or a loved one require expensive medical treatment. For these reasons, some individuals are turning to permanent life insurance to cover these unexpected expenses.
Permanent life insurance policies accumulate cash value over time. You can tap into the cash surrender value of your policy, but understanding the rules will save you money. This article covers how the cash surrender value works and other options for accessing your policy’s cash value component.
How Does Cash Surrender in Life Insurance Work?
Surrendering the cash value of a permanent life insurance policy involves terminating the policy and receiving the accumulated cash value, which is the amount of money built up within the policy through premiums paid and investment growth. Still, it may result in the forfeiture of the death benefit.
Who Can Surrender Their Cash Value?
The ability to surrender the cash value of a life insurance policy depends on your status as a policyholder of one of these types of life permanent insurance:
- Whole Life: Whole life insurance policies have a level premium and a guaranteed rate that your cash value grows. Some companies also pay dividends that increase the cash value beyond the guaranteed rate.
- Universal Life: Universal life policies also accumulate cash value, but the amount is based on interest rates, which can rise or fall over the life of the policy. With universal life policies, you can raise or lower your premiums within a specific range. But this will affect the cash account and death benefit.
In its early years, a policy’s cash value grows slowly. Growth accelerates the longer you hold the policy as funds earn tax-deferred interest.
How Much Will You Actually Receive?
When you surrender your coverage, the policy’s cash value is not the amount you’ll receive. Insurers subtract surrender charges to get the cash value minus surrender fees. Insurers calculate the amount you’ll receive based on several factors:
- Savings value: Life insurance policies have a savings component that builds cash over time. This component earns interest and grows tax-deferred. Policyholders can use their cash value by withdrawing or borrowing part of it. Withdrawing from the cash value typically reduces the amount beneficiaries receive after your death.
- Policy age: It takes time for cash value to accumulate in an insurance policy. Your policy might have a $0 cash value during the first year. Once you’ve built a cash value, it’s best not to cash out too early. When you cancel your account, insurers subtract surrender charges from the amount you receive. Your insurer calculates surrender charges based on gender, age, rating class, and coverage amount. These charges are higher in the first years of a policy and phase out after 10 – 15 years.
- Taxes: The cash value grows in your policy tax deferred. When you cash it out, you pay taxes on the amount you receive that is more than what you paid in premiums. For example, if your cash surrender is $30,000, but you paid $20,000 in premiums, $10,000 is taxable.
Can I Withdraw CSV At Any Time?
While it’s possible to surrender your policy and take a payout whenever you have a positive balance, you’ll save money if you wait. Your insurer subtracts surrender fees from your payout, which declines yearly. The longer you wait, the more you’ll receive. Also, keeping your money in the policy allows it to grow and earn interest tax free.
How CSV Works In Different Permanent Policies
Only permanent life insurance policies build cash value. But different types of permanent policies, such as whole and universal life, accrue value differently.
Whole Life Insurance
Whole life insurance has the simplest cash value process. The cash value grows by a fixed rate of return, and there is a minimum guaranteed growth rate. You pay a fixed premium and have a guaranteed death benefit. Over time, cash value increases with no risk of losing value. Because of its guarantees, whole life is more expensive than other types of permanent insurance.
Universal Life Insurance
The cash value of a universal life insurance policy is linked to current interest rates, which could go up or down. This type of policy is less expensive than whole life but can’t guarantee growth. Universal life policies allow you to raise or lower your premium payments within a specific range. However, if your premiums remain low for too long, it can reduce the cash value or possibly cause your policy to lapse.
What Taxes and Fees Are Associated With CSV?
When you cash out an insurance policy, you pay surrender fees representing a percentage of your policy’s cash value. A policy that is less than a year old might not have any cash value. The cash value grows as you pay more premiums over the years. Surrender fees range from 10% to 35% and decrease over time, often phasing out after 10-15 years. The IRS taxes the portion of your payout that exceeds the premiums you paid.
How To Receive The Surrender Cash Value Of Your Policy
If you’re considering surrendering your life insurance policy, review your statements and policy documents to learn about your balance and surrender fees. You can also access funds through a loan or withdrawal and keep the policy in force.
1. Determine If You Should Cancel Your Life Insurance Policy
Surrendering your policy means you’ll no longer be insured, and your beneficiaries won’t receive a benefit if you die. If your spouse and children can manage without a death benefit, cashing out the policy allows you to access the cash value now.
The cash value component of whole life policies grows by a fixed amount. However, universal life policies grow based on the performance of a certain fund or index. That means your policy’s cash value can rise or fall.
2. Request and Complete A Surrender Form From Your Insurer
The process for surrendering permanent life insurance begins with contacting your insurance company to let them know you’d like to surrender your policy. They’ll send you a form to complete. You’ll need your policy number and social security number. If there is another owner on the policy, you each must sign and date it.
3. Receive Your Payment
When you complete a policy surrender request form, it asks if you would like to receive your check or direct deposit. You should receive your payment within 30 days.
Is Receiving Your CSV Right For You?
It’s possible to access part of the cash value in a life insurance policy without canceling the coverage. Surrendering a life insurance policy should be a last resort after you’ve explored other options outlined below. Ending your coverage means your beneficiaries receive nothing if you die. Also, if you reapply for additional insurance, you’ll have to qualify for new coverage, which will be more expensive. Speak to your financial advisor if you are unsure if this is your best choice.
Who Should Consider Cashing Out Their Policy
In some situations, cashing out a policy for the cash surrender value makes sense for policyholders. Here are a few:
- Losing your job: If you lose your job and can’t afford your life insurance policy, you may need to cut it from your budget. Receiving the surrender cash value can help with bills until you get back on your feet.
- You need fast cash: If you need cash for tuition or an urgent home repair, the cash value can fit the bill.
- You no longer need life insurance: If your dependents are adults or you have ample investments, you might be comfortable canceling your life insurance.
- You want a different life insurance plan: Life circumstances can dictate different insurance needs. Maybe you prefer the lower cost of term insurance, or a death benefit is the only thing you need. If you’re buying new coverage, be sure it is in place before canceling the old policy.
- Cash for expenses
- Save on premiums
- Tax benefits
- Using your cash benefit
- Lower fees
- Loss of insurance coverage
- Potential tax implications
- Potential credit implications
Some advantages of surrendering your policy include:
- Cash for expenses: Get a cash infusion without going into debt if you have costly expenses like medical bills or tuition.
- Save on premiums: Because getting your cash surrender value ends your policy, you save the cost of premiums.
- Tax benefits: You may be eligible for tax benefits, depending on how long you’ve had the policy and if you previously withdrew from the cash value.
- Using your cash benefit: Your beneficiaries receive a death benefit when you pass away, but they don’t receive the cash value. That usually returns to the life insurance company. Cashing out your policy means you’ll access your cash value.
- Lower fees: If you’ve held your policy for ten or more years, it has accumulated a larger cash value. You’ll also get a larger payout after the surrender fees phase out.
There are also disadvantages to taking the cash surrender value:
- You lose your insurance coverage: Cashing out your life insurance’s full cash surrender value means canceling your coverage. Since insurance premiums increase with age, buying new coverage permanent insurance will be more expensive.
- Paying taxes and fees: Cash value surrender fees are higher for newer policies. If you cash out a policy less than 10-15 years old, you will lose some of your cash value to fees. The IRS taxes the portion of your cash out that exceeds the premiums paid.
- Credit Implications: While your policy is in force, you can borrow against your cash value with no credit check and no effect on your credit score. You’ll be limited to traditional credit sources when you cancel your policy. Borrowing from lenders will affect your credit score.
Alternatives To Surrender Cash Value Payouts
There are ways to withdraw cash value from your policy while keeping your coverage. Here are a few options:
Withdraw Part of the CSV
You can withdraw part of your cash value tax free if the amount is less than you’ve paid in premiums. If the amount you withdraw includes investment gains, that portion is taxable. The policy’s surrender charges reduce the amount of your cash value available to borrow. Ultimately, withdrawing funds reduces the life insurance benefit to your beneficiaries.
Using CSV To Pay Premiums
If you’re watching your budget, you can use your policy’s cash value to cover premium payments. Older adults who want to keep costs down while retaining their coverage often choose this option. Assuming you’ve built enough cash value, this option can help keep your policy in force. There is a risk that the payments could exhaust all the funds in the account and make your policy lapse.
Borrow Against Your Policy
Most policies allow you to borrow from your cash value. The insurer lends the money with your cash account as collateral. You won’t need a credit check, and the loan does not appear on your credit report. The borrowed amount is not taxable, and the loan accrues interest but at a lower rate than other credit products. If you don’t repay the loan, it reduces the death benefit payable to your beneficiaries.
Utilize Your Accelerated Death Benefit
One of the unique features of permanent life insurance is that some policies allow you to receive your death benefit while the policyholder is still living. This is known as an accelerated death benefit and is either a feature of a permanent policy or can be purchased as a rider.
If you’re diagnosed with a terminal illness, you can access a portion of your death benefit to pay for health care, long-term care, or whatever you need. Insurers pay a set percentage of the death benefit, usually 25% to 95%. Most policyholders don’t pay taxes on this payout.
To trigger this benefit, you must have a terminal illness, usually with a life expectancy of 12 months or fewer. Some insurers impose a service charge to access an accelerated death benefit. Typically, policyholders are no longer required to pay insurance premiums after receiving this benefit.
Sell Your Policy
Most people don’t realize that because life insurance is private property, policyholders can raise cash by transferring ownership. Selling a life insurance policy to a third party is known as a life settlement. The seller usually gets more for the policy than the cash surrender value but less than the death benefit. The buyer pays the policy premiums and receives the death benefit after the insured dies.
Older policyholders with poor health are most likely to sell life insurance policies. A life settlement helps if you can no longer pay your premiums. If you need cash for medical or long-term care, a life settlement might be the best way to raise it.
Licensed brokers handle the sale of life insurance policies. They charge a commission of up to 30% of the sales fee. You can avoid paying a commission by selling your policy directly to a provider. You will probably pay taxes on the proceeds from the policy sale.
Surrender Cash Value, and You
While surrendering the cash value can provide a lump sum payout, weighing the benefits against the potential drawbacks, such as the loss of the death benefit protection and possible tax implications, is essential. Policyholders should carefully assess their financial needs, future goals, and alternatives before opting for a cash surrender, seeking professional advice to ensure their choice aligns with their overall financial strategy. Whether for unlocking funds or adjusting a life insurance plan, a well-informed decision regarding cash surrender value can ultimately secure a more stable financial future.