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One of the benefits of a cash value life insurance policy is that you can access the money while you are alive. There are several ways you can withdraw money from the cash value, including surrendering the policy for a lump sum. Here’s how it works and when it makes sense to surrender a life insurance policy.
Ways to Access Cash Value on Life Insurance
If you have a permanent life insurance policy, it probably has a cash value component. There are several ways you can access that money as a policyholder.
You have the option of withdrawing funds from the cash value portion of your policy. As long as you withdraw only up to the amount you paid in premiums (known as cost basis) and not the profit you earned, you don’t owe tax. You can deduct more than the cost basis, but be prepared to pay taxes on that portion.
Withdrawals from the cash value will reduce the death benefit your beneficiaries receive.
You can also borrow against the cash value of your policy. There is no loan application process or credit check involved because you are essentially borrowing from yourself. You will need to pay interest, but the rates are usually low.
If you die before the loan is paid off, the outstanding balance is deducted from the death benefit paid to your beneficiaries.
Surrendering a life insurance policy means canceling the policy and receiving its surrender value, which is the cash value minus any surrender charges. If you go this route, the coverage ends. Your beneficiaries will not receive a death benefit when you die.
You will have to pay tax on the amount you receive that is above the cost base.
If you no longer want or need your policy, you can sell it to a third party in what is called a life settlement. You receive a one-time cash payment, often for more than the surrender value (more on that later). The buyer takes responsibility for the policy, including premium payments, and receives the death benefit when you die.
Life settlements are generally for elderly people in poor health.
When to surrender your life insurance policy
Considering the different ways to access your cash value on life insurance, you may think it’s better to surrender your policy for cash. Here’s a look at some scenarios when this might make sense.
You found a good deal
Although life insurance quotes tend to increase with age — and new health issues you develop — there’s a chance you’ll be able to qualify for a more affordable policy today than when you first took out your current insurance. For example, perhaps your health has improved significantly or you quit smoking.
In this case, it may be worth shopping around for a new one at a lower cost. Make sure your new policy is in effect before surrendering your current policy. Also, before purchasing new life insurance, see if a 1035 exchange can save you money on taxes.
You can’t afford the premiums
Permanent life insurance is more expensive than term life insurance. If the premiums are taking a large amount out of your income, you may be better off with a cheaper term life policy. Consider shopping around for term life insurance coverage to compare costs.
You no longer need life insurance
There are some instances when you no longer need life insurance coverage. For example, if no one is financially dependent on you, you may not need life insurance. Keeping your policy in force may not make financial sense.
You need a large amount of cash soon
If you have large expenses to cover or a good investment opportunity but no liquid assets to tap into, surrendering a cash value life insurance policy can be a decent option, especially if your actual need for life insurance has decreased.
How is the cash surrender value calculated?
The surrender value of the policy is based on the portion of the premium that goes into the cash value account and the interest rate or investment gain that is paid. From that, the outstanding loans are deducted, including any surrender charges.
Some policies take several years to build up any substantial cash value, so you may not have much cash value anyway.
Over time, surrender charges decrease. Ideally, you’ll wait until fees are minimal or non-existent. Also, the longer you hold the policy, the larger the cash value will be.
Also, remember that if your cash surrender value is worth more than what you paid in premium, you will need to pay income tax on the difference.
Finally, keep in mind that your beneficiaries will not receive the death benefit if you surrender your policy. So when exploring your options for taking cash value from life insurance, consider how each method impacts your long-term estate planning and goals. If you need cash there may be a better option.
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Surrender Life Insurance FAQ
Can you surrender a term life insurance policy?
You can cancel a term life insurance policy at any time, but since there is no cash value component included in the term life, there is no money to withdraw.
What is the cash surrender value?
Cash surrender value is the amount you receive if you surrender a cash value life insurance policy, such as a whole life insurance policy. This is the cash value you own minus any surrender charges. Surrender charges can last for around 10 to 15 years after you purchase the policy.
Will I pay tax on the cash surrender value?
If the cash surrender value you receive is more than what you paid through premium (cost basis), the amount you paid may be taxed. Talk to a tax professional to determine when life insurance is taxable.