How Cash Surrender Value of Life Insurance Works

Cash surrender value is the money you receive once you cancel or surrender your life insurance policy, minus surrender fees. Cash surrender value is a part of universal life, whole life, and variable universal life policies, excluding term life insurance — as it only provides death benefit protection without a cash value accumulation component.

Many life insurance policies offer the option to cancel the policy.

Depending on the type of insurance policy, you may have several alternatives to surrendering your policy. The reasons for a life insurance cash surrender can be multiple — your kids may have grown up and finished college, and you are looking for a different type of life insurance coverage.

In this article, we will cover everything about the cash surrender value of a life insurance policy, from how to calculate it to alternatives and everything else related to the topic.

Table of Contents

    Policy Cash Value

    Money growing over time representing cash value of insurance policy

    To understand the cash surrender value, you must understand what cash value is. Cash value, also called account value, is a component of permanent life insurance policies that acts as a savings or investment account, allowing you to accumulate cash and withdraw or borrow against the policy.

    As a policyholder, you can use your cash value account to cover unpaid policy premiums, supplement your retirement income, take out a policy loan, or use the policy’s actual cash as your emergency fund.

    The most common types of life insurance with a cash value are:

    Unlike term life insurance policies, all of these policies come with a cash value component, but each is slightly different in how cash value works.

    Cash Surrender Value of Life Insurance

    A man signing his policy papers to get the cash surrender value of life insurance

    Your permanent life insurance policy earns cash value over time through premium payments. Once you cancel the policy, your insurance company must pay a portion of the cash value or all of it to the policyholder.

    The cash surrender value is the money a policyholder would receive from the life insurance provider when they surrender a life insurance policy.

    What is the Difference Between Cash Value and Cash Surrender Value?

    cash value vs. cash surrender value table
    Image Source

    The main difference between the surrender value and cash value is the charge for early policy termination or early cash withdrawal.

    Insurance providers tend to charge fees or penalties for early withdrawals or terminations because they want you to proceed with the premium payments.

    Also, your insurance company can reduce the policy’s cash surrender value due to surrender fees when you decide to surrender your life insurance. After several years (typically 10 or 15), surrender fees are no longer in effect, making surrender cash value and cash value equal.

    Unfortunately, it is not uncommon if your insurer requires that you cancel the policy before you can get the surrender value. But this is the case only if you want to surrender it. If not, you are still allowed to take a loan against the policy’s cash value.

    How to Calculate Cash Surrender Value of Life Insurance Policy

    You can calculate your cash surrender value of life insurance in just two steps:

    1. Add all the payments applied to the policy.
    2. Subtract the surrender fees and outstanding balances against the cash value. (Outstanding loans and prior withdrawals, if any)

    Paying A Cash Surrender Fee to Your Life Insurance Company

    You can also calculate your surrender fees, which vary from one insurer to the next. Usually, surrender fees start at 10% but go up to 35% and gradually decrease as time passes. This is how you calculate cash surrender values, no matter what type of permanent life insurance policy you have.

    Cash Surrender Value Example

    For instance, let’s say that you choose a universal life insurance policy for $150,000. You are paying your policy for 10 years and collecting $15,000. However, you’ve found out about our community and the concept of infinite banking. Your kids are all grown up, and you want to switch to a whole life policy because it allows you to achieve the financial security you’ve always wanted.

    During the 10-year period (or over a decade), you’ve taken a $1,500 loan, and you found out that the insurer charges 3% in fees. That means you subtract the loan and the fees ($450 in this case) from the cash value, leaving you with $13,050.

    Keep in mind that surrender fees vary depending on the insurer. You can inquire about it before deciding on permanent insurance with a specific insurer.

    Is the Cash Surrender Value of Life Insurance Taxable?

    Money and tax papers on the table

    The next thing you should know is whether you will have to pay taxes on your cash surrender value. Cash surrender value is a tax-free return of principal up to the total amount of premiums paid.

    To illustrate, if your monthly premiums were $250 for a $100,000 whole-life policy and you regularly paid them for 30 months, you can expect about $7,500 of cash value to be tax-free because you paid that amount in premiums.

    But if your cash-value account earns any interest, dividends, or capital gains, you will have to pay taxes on this portion of your income. Generally speaking, any amount above the sum of the total payments will be considered taxable income. This means that you will have to pay tax on this sum at the top marginal tax rate.

    In other words, the cash surrender value is taxable, but only when the amount you receive in cash value exceeds what you have paid in premiums.

    Should I Surrender My Life Insurance Policy?

    Life insurance policy with 100 dollar bills next to it.

    Surrendering your life insurance sometimes makes a lot of sense, and canceling your policy is not a complicated process.

    Suppose your policy is relatively new. In that case, your cash value growth has been insignificant, so you won’t get almost any money if you cancel your insurance coverage. On top of that, the insurance agency will probably charge hefty surrender fees.

    Remember that once surrendered, you cannot reinstate your policy. You need to reapply and start a new one from scratch. This also cancels your death benefit, and your beneficiaries will receive nothing in the event of your death. This can be compared to canceling car insurance. Once canceled, you will receive no compensation if you crash.

    When to cancel life insurance:

    • You may no longer feel like you need your permanent or term life insurance policy
    • Your family members no longer need your support
    • Your beneficiaries passed away before you, and no one can receive your policy’s death benefit
    • You got divorced and have no other person to name as your beneficiary
    • You want to change your investment strategy
    • You are struggling and cannot afford to pay premiums
    • You need a cash source quickly

    How to Surrender Your Life Insurance Policy

    Canceling a contract or surrendering life insurance.

    If you want to stop paying premiums and cancel your life insurance policy, you might get a check from your insurer. You can get the money only if you have owned the policy long enough for it to build up actual cash value.

    Also, surrender penalties will probably eat up everything you’ve accumulated if you surrender in the first ten years. However, if your policy is older and you no longer need life insurance, you can cash it out with no fees.

    Some insurers even offer modifications to your policy, keeping the death benefits while you pay a reduced premium.

    Be cautious, because your policy will probably lapse if you stop paying premiums without an agreement with your insurer. Always consult your insurance broker first to determine what options your particular policy allows.

    As for the technical part, all you have to do is contact the insurer, fill out the surrender form, and they will get back to you with the net cash surrender value. We’ve already told you how to calculate your cash surrender value, so you can do that as you wait to ensure everything is alright.

    Alternatives to Surrendering Your Policy

    Surrendering your permanent life insurance policy can be costly, especially if you have to pay high surrender charges. Remember that the surrender fee can be up to 35% at the very beginning, and sometimes the cash surrender value isn’t worth it.

    Therefore, we’ve provided three alternatives:

    • Withdraw the policy’s cash value

    In many cases, you can directly withdraw the remaining cash value and use that money elsewhere as an emergency fund.

    Most insurers require policies to be active for a specific term before accessing cash values. This period is called the surrender period. On the other hand, you should expect to pay surrender charges if you cancel your policy during the surrender period.

    • Take Out a Loan

    The easiest way to get quick money through the policy is to access the cash value by taking out a loan and using the policy as collateral. The interest will be charged; however, the rates are significantly lower than you would pay other traditional lenders, especially if you don’t have an excellent credit history.

    • Sell your policy

    Selling your life insurance policy is not much different from selling other valuable assets that will generate immediate cash.

    If you are an eligible candidate to sell your policy, you might get a bigger payout than with cash surrender value, and this transaction is called a life settlement. If you want to learn more about the life settlement process, contact your insurer.

    At the end of the day, it all comes down to what works for you. When you surrender your policy, you have to start over. At no point can you continue paying as if nothing happened. If you want to surrender your policy to get whole life insurance and start investing, make sure you plan it out. 

    If you already have a whole life, canceling it isn’t a good idea; you can use it to build an independent banking system and get the most out of this policy instead.

    • Build Your Own Banking System 

    Last but not least, you can choose to keep your policy and start building your own banking system around it. The system is based on overfunding your whole life insurance and using the cash value as collateral to borrow money from your insurer and use that money to invest. 

    The key to success is to pay your premiums early and build up cash value as soon as possible to use this as your foundation. But since you are considering surrendering it, there’s probably enough to get you started. 

    Put Your Banking System to Work Today

    Hopefully, we answered all your questions about the cash surrender value of life insurance. Before surrendering your policy, we recommend you check one of the alternatives first and then decide what to do.