Cash Surrender Value: What It Is and When to Use It

Cash value life insurance is a type of permanent life insurance policy that includes a savings component. Policyholders can access the cash surrender value of life insurance policies. If you are shopping for life insurance or currently have an existing policy, read this guide to better understand cash surrender value, how to calculate it, and how to compare alternative options.

There are two types of life insurance policies: term insurance, which is temporary, and permanent insurance, which lasts the insured's lifetime. Term policies only pay a death benefit if the insured dies during the term period. Permanent life insurance or cash value policies provide insurance protection for an individual's lifetime.

The premiums for permanent policies cover the cost of the life insurance policy and build a cash value (savings fund) within the policy. The cash value amount depends on the premium paid, the duration of the policy, and the interest rate the policy earns. The cash surrender value is different from the death benefit. Term life insurance policies do not offer a cash value.

The cash surrender value of a life insurance policy is the amount of money (minus fees) the policyholder will receive if they voluntarily surrender or terminate the policy. The insurer will give the amount that the policy is worth based on the premiums and the interest the company has earned on the policy. For example, if a policyholder purchases a universal life insurance policy, then decides to cancel it, the cash surrender value is the amount the insurance company would pay when the policy is canceled. The amount paid is typically less than the accumulated cash value because insurance companies often withhold fees and charges, much like a termination fee on a contract.

Policyholders may decide to surrender their life insurance policies for a couple of reasons. They may no longer need the coverage, or may need the cash for unexpected expenses.

The policyowner may surrender the policy at any time for its cash value minus any debts against the policy, and surrender charges. The life insurance coverage is then canceled, and the policy cannot be reinstated.

Policyholders need to contact the life insurance company to surrender the policy. The insurance company will request that the policyholder fill out a form to submit. The policyholder then receives the life insurance surrender value from the insurer.

Depending on the life insurance policy's fees and when a policyholder cancels the policy, the cash value and cash surrender value may be different. Here's how it works.

Cash value vs. surrender value

The cash value is the amount the insurance company places in the cash value, or savings fund, within the policy. The cash value amount depends on the premiums paid, the duration of the life insurance policy, and the interest credited to the account.

The calculation is based on the premiums paid by the policyholder and the interest earned by the insurance company on invested money. Depending on the policy, the interest could be a fixed rate, a variable rate, or a combination of both. Generally, the cash surrender value accumulation takes time. The longer the policyholder has paid their premiums, the larger the accumulated value.

The cash surrender value is the amount a policyholder receives for cashing out or surrendering the policy. The surrender value is calculated by subtracting any debts against the policy, and surrender charges or other fees from the cash value. In the early years of a policy, the cash surrender value is often less than the cash value, due to the surrender charges and other fees the insurer may charge. Usually, the cash surrender value amount increases as the policy's cash value increases -- and surrender charges usually decrease as that happens.

The cash value and cash surrender value may be the same amount if a policyholder has held the policy long enough. Policyholders should review their policies to determine surrender fee amounts. It is best to contact the insurance company to get the exact cash surrender value. It may be worth waiting until the policy is out of the surrender charge period, or accessing the cash value through alternative means (such as borrowing against it, among other options).

What are surrender fees?

A surrender charge is a fee imposed on the owner of the life insurance policy if they surrender the contract. Before cashing out a life insurance policy, policyholders should calculate the surrender fees and any other fees the insurer may charge.

Life insurance policies are intended to be held long-term. To discourage policyholders from accessing their cash value in the short term and to recoup their initial costs, insurers charge surrender fees.

Surrender charges vary among insurers, and are calculated as a percentage of the cash value of the life insurance policy. Surrender fees typically are 7% to 10%, and decrease by 1% every year. Some insurers impose surrender fees for as long as 15 to 20 years.

One of the benefits of a cash value policy is tax-free growth. But is the cash surrender value of life insurance taxable? The cash surrender value is not taxable on the premiums paid into the policy. Any investment gains, however, are taxable.

For example, if a policyholder receives a cash surrender amount of $10,000 and paid $7,000 in premiums, the $3,000 gain is taxable income.

If the cash surrender value of the life insurance policy is higher than the premiums paid, the policyowner has to pay taxes on the earnings when the policy is surrendered.

It is important to explore alternative options before deciding to surrender a life insurance policy, because once it is canceled, the policy cannot be reinstated. It may be difficult to qualify for a new life insurance policy depending on age and health. Here are some other options to consider.

Borrow from the cash value

If a policy is subject to surrender charges, a policyholder can borrow from their life insurance cash value and maintain coverage. The loan must be paid back with interest, or the death benefit is reduced.

Partial withdrawal

Policyholders can surrender a partial amount instead of canceling the entire policy. If the amount withdrawn is less than the premiums paid, the partial amount surrendered is not subject to taxes. Surrendering a portion of the cash value may reduce the death benefit amount.

Sell your policy

Policyholders can sell a life insurance policy to a third party. This is known as a "life settlement." The amount the policyholder receives depends on age, health, and other factors. The policyholder gets a lump sum of money and is no longer responsible for making premium payments. The amount received, however, may be far less than the death benefit. Life settlement brokers also often charge high fees. The policyholder also has to pay taxes on the settlement amount, unless they are terminally ill.

Use the cash value to pay premiums

If a policyholder is having difficulty paying the premiums, some policies have a provision by which the premiums can be deducted from the cash value. Depending on the cash value and the interest earned, the death benefit may be reduced.