The cash surrender value of life insurance is the amount an insurance company will pay you as a when you surrender or voluntarily terminate your policy before it reaches its maturity or before the events covered in the policy occurs.
Permanent life covers you for the duration of your life but more importantly, it offers a benefit known as cash value. In this sense, permanent life serves two purposes, it protects your family in the event of your death, but also can serve as a financial resource you can depend on when thing get worse financially.
Permanent life policy allows you to surrender your policy, thus terminating the policy. The insurance company pays a cash value when you terminate the policy.
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There are many things that a company will consider when offering a cash surrender value.
This post examines surrender value in details covering the essence of surrender value for insurance, cash value, whether it’s worth it, the tax implication and how it means to you as a policyholder.
What is the Cash Surrender Value?
When you decide to terminate your life insurance policy, you are requesting your provider to cancel the policy in exchange for the cash value that you have accumulated.
Only permanent life insurance policies offer this benefit, this includes policies such as whole life and universal life. These two offers a premium saving component and a death benefit.
Cash Value vs. Surrender Value
The two are inherently the same but do not confuse them, the difference is that the surrender value is the amount you receive when you choose to cancel or cash out the life insurance policy.
In this case, the surrender value will be less than the cash value. The charge varies from one company to another, and often stipulated on the policy contract.
Note that the cash value is the amount is the sum of the money accumulated and the interests or bonus if any.
How Does It Work?
Think of life insurance like any other contract.
When you sign up that policy, you are essentially entering into a contract with the insurance company, that, in case you lose your life, the company will have to pay a certain amount.
But like any contract, there are terms for this contract, that for you to receive your entire amount, or death benefit and other benefits you are supposed to contribute premium until the end of the policy. Thus surrendering the policy essentially means you are breaching the contract.
Like any other contract, you are supposed to pay the other party some damages, but in this case, the insurance company takes part of your contribution to cover the damages and then ends the contract. The amount they pay you is called the surrender value.
Depending on the age of the policy, and the type of policy, the value could be less than the accumulated amount, because as noted, the insurance company has to recover their damages. The damages, in this case, are the fees and the commission paid.
We will have a look later on how much you should expect to receive as a cash surrender value.
When You Can Claim It?
It takes time for a policy cash value top rise because the very time you begin to pay your premium, the insurance company has to pay commission and other startup costs, including administration costs.
Therefore, many companies will not allow you to claim your cash value before a surrender period which is basically two or three years.
After two years, you will have accumulated a substantial amount into your life insurance. In almost all whole life insurance plans, the amount is guaranteed, but it is only accessed after the surrender.
Typically, life policies like the universal life often include a surrender charge, but after a certain period, say 10 years, a company may eliminate the surrender charge.
Borrowing Against the Cash Value
Depending on the term of the policy, surrender may mean terminating the policy, but there are options where you can access a portion of the fund and still have an active policy.
Some insurance allows you to borrow against the policy cash value as the collateral, but some provider may not. It would be a good idea to choose a provider who offers such benefits.
The main advantage of borrowing against the cash value is:
- You qualify for the loan, even when you have bad credit and you can choose whether to pay the loan or not, although this has some disadvantages on your side.
- Loans received using this means are tax-free unless you surrender the policy.
Kindly note, however, that
- Surrendering a portion of your case values or borrowing against is means reducing your death benefit.
- Sufficient cash value must always be there to support the death benefit, so in a whole life plan, the loan taken is not cash surrender, therefore the levels of the cash value may not be affected.
- If cash value, however, in universal life falls below a minimum level of growth required to sustain the death benefit, then the policyholders must put enough money to the policy otherwise, it may end up lapsing.
Is Claiming Surrender Value Really Worth It?
Everyone loses when an insurance policy is surrendered, that is the company, the policyholder and the agent.
Life insurance is considered a long-term contract and the longer policyholder keeps paying the policy the better the benefits will be.
So you surrender the policy;
- You are surrendering the benefits of life policy, and may not get the full cash value. In some situation, you may get less than 50% of the premium paid excluding the premium of the first year depending on the company calculation of surrender value.
- Should you seek the same cover again, you will pay more because your age has increased which increase the risk of covering your life and hence more premiums.
The company and the agent also lose in many ways.
However, there are two circumstances when policies should be surrendered;
- If the policy is not efficiently managed and you realize that your policy is not efficiently managed in terms of the bonuses, returns, and claims settled, then surrendering the policy may be a better option. You realize that you could get better coverage, then surrendering is a good choice.
- Your financial condition has changed. If you cannot be able to pay your premiums regularly, it is a good decision to surrender the policy. Some company, however, adjust the premium, and the coverage accordingly, while others may treat the policy as paid-up, where the policy continues but you receive lesser benefits but without paying premiums in the future.
How to Calculate Cash Surrender Value of Life Insurance
“In most cases, the value will be less than the face value of the policy.”
Any life insurance policy surrendered before the lock-in period may not have a surrender value. Those that are surrendered after this period have a proportionate surrender value which can vary from one company to another and from one policy to another.
Generally, the surrender value will be calculated using these three factors
- The length your policy has been in force and the amount paid.
- The market performance for the investment part of the policy and the percentage amount the company agrees to invest in your fund.
- The surrender charges that the company use.
When you first signed the proposal form, you were probably shown by an insurance agent a forecast and plan on how your money will be invested and how it will grow over time.
Most likely, you were given a five year or ten years projection. Indeed, your cash value will grow over time, however, it will depend on the performance of the investments and the percentage you agreed should be invested.
Insurance that chooses a strong investment may generally give you a good return for your money. The surrender charges may vary from one provider to another and even among policies.
The aim of the charge is to discourage policyholders from surrendering the policy until it reaches maturity. The longer the policyholder has the percentage the lower the percentage a provider will charge.
Normally, the surrender value is calculated as the accumulated saving or cash value, minus the surrender charges and acquisition cost, and any unpaid loan principal or interest.
Need an equation?
Here you go
“Surrender Value = Cash Value – Charges – Acquisition Cost – Loan/Interest”
The regulatory bodies in different areas have set a norm, where the amount paid also depend on the premium paying terms and the year you surrender.
Is It Taxable?
For now, the surrender value is not subject to tax, which means that no tax deduction will be seen when you receive the amount.
However, the amount you receive may not include the dividend or bonuses earned during the life of the policy. Since you have used the tax money to pay the premium, you won’t pay again for the surrender amount.
Other Tax Implication
Tapping cash-free values are tax-free but the withdrawals must not exceed the amount paid in premiums over the life of the policy. If it does, you will only be taxed the amount on top of your premium contribution.
So, if you have paid $10000 in premiums over the life of the policy, you will have no tax owed if you withdraw anything below $10000. If the policy lapses after you have cashed out more than paid in premiums the withdrawal will be taxed. This also means that if the surrender value includes the dividends, then you will be taxed on the dividends.
Generally, a surrender value that exceeds your premiums is very rare and it can take up to 15 years of premium payment for such a situation to occur.
You can use the cash value of your whole life as collateral for a loan such as education, home improvement, and auto purchase. The loan amount and the interest is deducted from the cash value should you decide not to pay.
What Happens After Death?
Once you receive cash surrender amount, it means that you have terminated the contract.
Hence, your beneficiaries will not receive anything from the provider.
If you have used the cash value to take a loan or otherwise, the insurance provider will absorb it after your death and your beneficiaries are paid the death benefit. This is different with term insurance policy where the death benefit is paid when you lose your life within the term of the policy. If you have an outstanding loan, the death benefit paid your beneficiaries will be reduced.
Cash value has its advantage, but you must exercise a little bit of caution especially when it comes to a whole life policy. The last thing you need is to get into a difficult tax situation, but since the cash value will be absorbed when you die, you do not want to leave it unused.
If you have a whole life with a high cash value, you should not consider surrendering. The surrender value is significant. Consider asking your insurance company for a higher value for the death benefit in exchange for the cash.
Cash surrender value is an excellent way of accessing your fund when the thing gets bad financially. However, this in most cases means canceling the policy and therefore forfeiting the benefit that comes from your life insurance policy.
The surrender value will help you meet your present financial goals; however, the amount you receive is significantly lower than the cash value. The best way to go about it is to consider other ways of getting cash from the insurance without having to surrender the policy.
Borrowing or using part of the cash value is a better option, but make sure you consult your insurance agent to understand the terms and condition as well as the advantages and disadvantage of each option.
However, if the life policy management does not make financial sense to you, or you no longer need life insurance, then ask for a surrender value.