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 buy a permanent life insurance policy, most policies include the opportunity to develop cash value. In whole life insurance, your premiums go to purchase the death benefit after a nominal annual fee is paid to the insurance company, typically under $100 per year. Premiums paid toward a universal life insurance product pay a fee to the insurance company first. This fee is a percentage of the premium you pay and therefore is higher the more your premium is. After this fee is satisfied in universal life insurance products, the cost of insurance will be deducted from your premium, and what is left after fees and the cost of insurance will become your accumulated cash value. So each time you pay a premium, if the premium is large enough, you’ll accumulate more cash value. If there comes a point when you choose to surrender your policy, then your insurance company will return the cash value to you in a whole life policy or universal policy. They will subtract the surrender fees from your accumulated cash values and pay you the difference.  Cash value returned to you is different from a viatical settlement, a life settlement, or extra value received from an accelerated benefit rider. 

Cash Value vs. Cash Surrender Value

Many wonder if it’s correct to use the terms ‘cash value’ and ‘cash surrender value’ interchangeably. These terms are essentially synonymous, but there is one instance when they’re not. Most universal life insurance policies include a period of time called the ‘surrender period’ where you’ll be charged surrender fees if you terminate your policy. These surrender periods are often 10 to 15  years in length, but some can be shorter in policies issued earlier. 

If you surrender your policy during the surrender period of a universal life insurance policy, the insurance company will take your cash value and deduct the surrender fees established in the universal life insurance contract. These fees can be quite expensive (especially if you surrender a policy in the first few years) but slowly decline over the surrender penalty time period of the contract. This situation is where the surrender value of a universal life insurance policy won’t equal accumulated cash value. In whole life insurance contracts, the cash value and the surrender value are equal from day one.  Only policy loans or interest owed on a policy will reduce the cash value of a whole life insurance policy. 

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 10-15. Many times this “break-even” point can be reached as soon as years 5-7 depending on your age, health, and total amount of premiums paid in a whole life policy. 

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 choose to surrender their life insurance policies for a variety of reasons. One major reason is to have money to use in retirement when a death benefit might not be so critical. Another reason is to stop the premium payments. When these situations occur, you might consider surrendering your policy. But is it worth it in the long run? 

The answer depends on the type of life insurance policy you have. If you have universal insurance, you might not accumulate much cash value over time because of the way the policy is designed. You could be paying large premiums to get little money back out of it. But if you have whole life insurance, keeping your policy can serve you in the long run—even during retirement. Whole life insurance guarantees cash value, which means you’ll always be accumulating more over time. This cash value can then be used to help with retirement or other expenses. A well-designed whole life insurance policy can provide more options and value than merely surrendering it. Whole life insurance can be used for passive income, or it can be rolled into an annuity to provide a guaranteed income for you for the rest of your 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. 

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.