Majority of Americans associate life insurance solely with the aspect that it is purchased to protect the ones we love. They might be in doubt some times says “Should I surrender my life insurance policy or not“
Although, with permanent contracts, there is another advantage which is often ignored — the surrendering value.
But before you can also check what is your whole life insurance calculation is?
The money that is stored away from the public eye for you in times of financial difficulty is what the cash value of the surrender is. If you terminate your contract ahead of schedule, this is the amount that will be returned to you. Yet beware of deceivingly low and short-term benefits because surrendering your life insurance sooner than expected may lead to penalties, taxes, and regrets in the long run.
If you want to know about the different ways of calculating the surrender value, explaining the term manifestation, the prerequisites for redeeming the amount and even why it is not always your best choice — this is the guide for you. Before you decide to ditch your policy, you need to be aware of the conditions of your new path.
What Is Surrender Value in Life Insurance?
Surrender value is the money you get from the insurer in case you decide to cancel your permanent life insurance policy before a demise event.
This has an effect on:
- The whole life insurance
- The universal life insurance
- The indexed or variable universal life insurance
As there is nothing like a cash value within a term life policy, these plans provide no surrender value in most cases.
The surrender value is also known as:
- Cash surrender value
- Policy cash value (less charges)
- Net cash value
Basically, it is what you keep if you let go of the policy which is either yours or that you can no longer afford.
How Is Surrender Value Calculated?
Figuring out the surrender value is much more complicated than a mere glance at the policy balance. It takes into account several factors:
1. Total Premiums Paid
This consists of all the premiums you have paid going back to the beginning of the policy. In the case of whole life insurance, part of your premiums is used to increase the cash value.
2. Cash Value Accumulation
Every time you pay a premium, the cash value of the policy is increased – it is similar to a savings account. This account gets bigger and bigger over time, usually at a rate of interest that is either fixed or variable, depending on the type of your policy.
3. Surrender Charges
These are the costs that the insurance company subtracts from the money that you would get were you to cancel the policy. They are typically the highest in the first 10 years of the policy and lessen gradually as time passes.
4. Outstanding Loans
Say you borrowed a little money against the cash value of your policy – then the unpaid portion of the loan will be taken out of the surrender value.
Example:
Suppose:
- The total premiums that you have paid add up to $25,000
- The cash value of your policy is $18,000
- There is a $2,000 surrender charge
- You have a $1,000 outstanding loan
The amount of your surrender value = $18,000 – $2,000 – $1,000 = $15,000
When Can You Access the Surrender Value?
The removal value of your policy can be reached anytime after the policy has a cash value; however, a few caveats are:
- Most insurance policies require 2-5 years to grow any solid cash value
- The surrender cost is usually at its highest in the first 5-10 years
- Some contracts may have limitations or penalties related to early termination
The more you preserve your policy, the more your surrender value increases — and the lower the amount of penalties you are entitled to.
This is why financial advisors seldom recommend cashing out unless you are in an absolutely forced situation.
Why Do People Consider Taking the Surrender Value?
It is surrendering the policy that feels like the best decision in only a few scenarios.
1. You Need Immediate Cash
Getting sick, the house breaking down, or losing the job are the situations that might leave you with no option, but hacking into your savings. A surrender payout may be the solution that keeps you going.
2. You No Longer Need Coverage
If your children are self-sufficient adults, the house is paid for, and nobody relies on you for finances; then you might be feeling that the life policy is now a burden rather than a help.
3. Your Policy Isn’t Performing
Particularly are variable or indexed policies that do not evolve as per your expectations of growth. The disappointment is one of the main reasons that cashing gives a solution to retirees.
4. You’re Retiring With Other Coverage
Once you have a secured retirement capital plan such as a 401(k), pension, or annuities, why would you want the additional cost of a permanent life policy?
But prior to getting the surrender value, ask yourself if you are really making a progress or just responding to temporary requirements.
The Financial Risks of Taking the Surrender Value
Claiming a policy surrender is a major financial decision. Although this move may be used to obtain money quickly from the policy, on the other hand, it can lead to a series of long-term financial problems.
1. You Lose Your Death Benefit
This is the most significant consequence. Along with it also goes the death benefit that your family would have received without any deductions in case of your death.
If you opt for a new policy instead, it will most likely be more expensive or it might be that you will not pass the medical test because of age or health problems.
2. You May Owe Taxes
The IRS considers the surplus between the surrender value and the premiums paid by the policyholder as taxable income.
Example:
- Premiums paid: $20,000
- Surrender value: $30,000
- Taxable income: $10,000
This income can cause you to move to a higher tax bracket, which can lead to higher taxes than you expected when filing your tax return.
3. Surrender Charges Can Be High
The amount you can surrender during the first years of a policy is mostly charged with high surrender fees — those fees can take a big portion of your cash value and leave the remaining part of it even lower than the amount you originally paid.
Unless you have a copy of your policy statement or you have talked personally with your insurance company, it is not safe to assume you will get a specific amount.
Alternatives to Taking the Surrender Value
The idea of letting go off your policy due to a temporary financial situation or because you are disillusioned with your returns might not be the only alternative. Besides these reasons, you still have other better options.
✅ 1. Take a Policy Loan
Instead of terminating the policy, take a loan against your cash value. You hold your insurance and get the money you need, usually at a low-interest rate. The only thing you have to remember and that is, if you don’t pay it back, it will be deducted from your death benefit.
Expand your knowledge of this approach by reading our partial surrender vs policy loan comparison guide.
✅ 2. Reduce Your Coverage
Notably, many insurance companies provide you with an option to decrease your death benefit resulting in an excellent opportunity to reduce your premium costs. In this case, you will continue to have some level of protection.
✅ 3. Convert to a Paid-Up Policy
Provided the growth of your cash value surpasses the minimum requirement, you can transform your policy into a paid-up contract, which means you wouldn’t have to pay any more premiums, but the plan will continue to provide a reduced death benefit.
✅ 4. Sell Your Policy (Life Settlement)
If you are above 65 and meet the requirements for your policy, you might be allowed to sell it to a third party for a price that is higher than the surrender value. This process is called a life settlement and can be a more advantageous way of getting out of the policy.
We make this process clear with examples in our article: how to sell your life insurance policy legally.
Questions to Ask Before Surrendering a Policy
- After deducting all charges and loans, what exactly will be my surrender value?
- Will this action have an impact on my retirement or estate planning objectives?
- If I terminate my current policy, might I be eligible for a different one?
- Is there a more effective way to get hold of my money without having to pay premiums?
- Have I consulted a fee-only financial advisor?
Do not allow transient feelings to decide your fate. See the reality of the picture before making the next move.
Real-Life Example: How Surrendering Too Early Can Backfire
Mark, 58, from Illinois, after being laid off, terminated his universal life insurance policy. Mark got $11,000 as a surrender value — but he was not told that he owed $2,200 in taxes.
One year later, he tried to get a new policy but was turned down because of some health problems that he didn’t have at the time of the first policy. So, the $200,000 coverage that he had before and that would have given his family comfort was out of the question now.
Mark was quoted as saying, “If I had the information about the loans or the paid-up policy, I would not have gone through with the cancellation. I acted too quickly.”
Conclusion: Know What You’re Trading Before You Cash Out
The surrender life insurance value can serve as a resource in distressful situations — however, it is not the most rational decision all the time.
You can be given cash on the spot but at the cost of your long-term protection, you can also be penalized with taxes or you even erase part of your heritage planning. Instead of getting to the point of canceling outright, take a look through your possibilities with a qualified advisor, do the math, and look at other, less severe alternatives.
When you give up your life insurance policy, it is not possible to go back in time. Ensure that your choice is made with a plan in mind and not out of despair.
