What Is Cash Surrender Value? A Guide to Understanding Your Policy

What Is Cash Surrender Value?

The cash surrender value is money the insurance company will pay you if you voluntarily surrender (or end) your permanent life insurance policy. You can also think of cash surrender value as the present value of your paid-up insurance in whole life insurance and the accumulated cash value minus surrender charges in a universal life insurance product. The value of your cash surrender can be different from the total cash value in the policy in a universal life insurance policy, depending on the age of the policy and the cost of the surrender fees associated with universal life insurance.

Surrendering your life insurance policy means that you forfeit the death benefit, but you won’t have to pay any more premiums. This process is different from borrowing against your policy. Borrowing against your policy involves your cash value, but it keeps the policy and death benefit in place. 

How Does Cash Surrender Value Work? 

When you purchase a permanent life insurance policy, you gain the opportunity to accumulate cash value in most policies. In the case of whole life insurance, your premiums primarily fund the death benefit after paying a nominal annual fee to the insurance company, usually less than $100 per year. For universal life insurance products, your premiums first cover a fee charged by the insurance company. This fee, a percentage of your premium, increases with the premium amount. Once you pay this fee in universal life insurance, the company deducts the cost of insurance from your premium. The remaining amount, after fees and insurance costs, contributes to your accumulated cash value. With each premium payment, especially larger ones, you enhance your cash value. If you ever decide to surrender your policy, the insurance company will refund the cash value from either a whole life or universal policy, deducting any surrender fees from your accumulated cash values before paying out the remainder. The cash value you receive differs from amounts obtained through viatical settlements, life settlements, or the added value from an accelerated benefit rider.

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Cash Value vs. Cash Surrender Value

Many people question whether the terms ‘cash value’ and ‘cash surrender value’ can be used interchangeably. These terms are essentially the same, except for one specific scenario. In most universal life insurance policies, a ‘surrender period’ exists, during which the insurance company charges surrender fees if you cancel your policy. These surrender periods typically last 10 to 15 years, though they can be shorter in policies issued earlier.

During the surrender period of a universal life insurance policy, if you decide to surrender your policy, the insurance company will subtract the surrender fees, as stipulated in the universal life insurance contract, from your cash value. These fees can be substantial, particularly if you surrender the policy in the initial years, but they gradually decrease over the contract’s surrender penalty period. It is in this context that the surrender value of a universal life insurance policy may not match the accumulated cash value. For whole life insurance contracts, however, the cash value and surrender value are identical from the outset. Only outstanding policy loans or interest due on a policy will diminish the cash value of a whole life insurance policy.

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How to Calculate Your Cash Surrender Value

There are several factors that go into determining your cash surrender value. These are some of the most important factors that can help you calculate your value: 

• The type of life insurance policy you have. Whole life policies guarantee a fixed cash value, as well as potential earnings from dividends. For universal life insurance policies, the cash value growth depends on the market index or indexes that the policy is mirroring. For variable life insurance, the cash value depends on the sub-accounts which are actually invested in the market having purchased equities or securities. The type of permanent life insurance you have and the way the policy is designed affects how cash value is generated, and in turn, this affects your cash surrender value. 
• The duration of your policy. How long you’ve had your policy will affect your surrender value. With whole life insurance, the cash value builds slowly but is guaranteed. After 3-5 years, the cash value can often grow by more than the premium amount paid each year. With universal life, the cash value is really just an extra premium you have paid for term insurance coverage plus any growth these extra dollars have earned in interest. If you haven’t had your policy longer than the surrender period, your surrender value will be lower than the cash value. 
• The policy’s fees. Depending on the policy you have, you may have a variety of fees that will affect your surrender value. Some universal policies have exorbitant fees that will reduce how much of your premium payment is going toward cash value. Whole life policies have a flat annual fee that rarely is over $100 annually.
• The amount put into the account. Paying larger premiums doesn’t always mean more cash value. A well designed permanent life insurance policy should have a guaranteed cash value greater than the total premiums paid for the policy by years 12-17. Many times this “break-even” point can be reached as soon as years 7-10 depending on your age, health, and total amount of premiums paid in a whole life policy. 

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Once you take fees, time of ownership, type of policy, and premiums into account, you’ll have a better idea of your potential surrender value. Essentially, if you know how much cash value you have, you can subtract any surrender fees or policy loan interest and balance, and that will be your surrender value. 

Taxing Surrender Value

Life insurance has preferred tax treatment when it comes to withdrawing money. This is called FIFO (first in first out). This means cash surrender value can be withdrawn tax-free up to the cost basis of the policy (amount of premiums paid into the policy), before having to start paying tax on the growth. For example, if you paid $20,000 into a whole life insurance policy, you could withdraw (surrender) $20,000 from your cash value tax-free because you’d have paid that much in premiums already. 

Is It Worth Surrendering Your Policy? 

People often surrender their life insurance policies for various reasons, such as needing funds for retirement or wishing to cease premium payments. When faced with such decisions, the question arises: is surrendering your policy beneficial in the long term?

The answer hinges on the type of life insurance policy you possess. With universal insurance, the design of the policy may result in minimal cash value accumulation over time, leading to substantial premiums for limited financial return. Conversely, maintaining a whole life insurance policy could prove advantageous in the long run, especially during retirement. Whole life insurance ensures a guaranteed cash value accumulation, providing a financial resource for retirement or other needs. A strategically crafted whole life insurance policy offers more benefits and options than simply surrendering it. It can serve as a source of passive income or be converted into an annuity, ensuring a steady income for life.

Alternatives to Surrendering a Life Insurance Policy

Even if premiums are costly or retirement is nearing, surrendering a policy isn’t the only option you have: 

• You can borrow against your policy. One of the benefits of permanent life insurance is the opportunity to use the cash value. You can borrow against your policy and use the cash for retirement or pay for large expenses, like a child’s college tuition. 
• You can withdraw from your cash value. The cash value can be withdrawn and used for anything you need or desire. There are no restrictions on when, how, or why you use the money like there is with 401(k) plans and IRAs. You can continue to keep a large amount in the account itself, but you can use some of it long before you ever use a death benefit. 
• You can roll your life insurance into an annuity, providing you with a guaranteed income for your entire lifetime.
• You can look at a life settlement. If you’re a viable candidate for a life settlement, it can include a higher payout than if you merely surrender your life insurance policy for its cash value. 

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Ultimately, if you aren’t sure what the best solution is to your life insurance questions, we can help. Here at McFie Insurance, we provide free strategy sessions where we can help answer your financial questions and guide you through the process of using life insurance to your advantage, including cash surrender value questions. Schedule a strategy session today, and we’ll help you get started.

Ben T. McFie

There's a lot of confusion around finance; there's so much to know and it's frustrating when you don't know enough to make the best financial decisions. I like to bring clarity to financial matters so people can make good financial decisions that will help them live wealthier more fulfilling lives.