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Cash Surrender Value of Life Insurance: A Straightforward Guide

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    Life insurance is not lacking for (unnecessarily) complicated jargon.  And cash surrender value fits that bill perfectly.

    The cash surrender value of life insurance is simply the money you get from your insurance company if you cancel your policy.

    Let’s dig in more.

    What Is Cash Value?

    Cash value is just cash.  It’s actual cash that sits in a savings account (called a cash value account) within any permanent life insurance policy you buy. 

    Cash value life insurance policies, such as a whole life policy, a universal life policy, and variable life, have a cash value component, whereas term life insurance does not.

    As we’ll discuss below, this cash value can be accessed by the policyholder through a policy loan or by surrendering the policy for its cash surrender value. The cash value typically earns interest or dividends, and the growth is tax-deferred until the policyholder withdraws it. 

    What Is Surrender Value?

    Life insurance cash surrender value is a feature of a life insurance policy that allows policyholders to access the cash value of their policies. This is done by allowing the policyholder to terminate their policy and receive the cash value that has been built up over the course of their policy.

    The Risks of Surrendering

    The cash surrender value is typically much lower than the death benefit of the policy, so it’s important for policyholders to understand the risks associated with accessing this cash value, as it could result in a significant loss of potential death benefit.

    Additionally, accessing the cash surrender value can cause policy loans to be taken from the death benefit, leaving less money for the beneficiaries at the time of death.

    Which Policies Have Cash Surrender Value?

    Cash surrender value is a feature of permanent life insurance coverage (e.g., whole life insurance, universal life insurance, variable universal life policies) policies. 

    Unlike a term life insurance policy, a permanent life insurance policy can accumulate cash value over time, and the policyholder can withdraw or borrow against this cash value if needed.

    As the cash value of the policy grows, the policy’s cash surrender value also increases. At any point, This means that the policyholder can opt to surrender the policy at any time and receive the cash surrender value.

    How is cash surrender value calculated?

    Life insurance cash surrender value is calculated by taking the:

    • Net premiums paid
    • Minus outstanding loan amount
    • Minus surrender fees

    Note that the latter two items may not apply to your policy. To understand the exact cash surrender value formula, policyholders should refer to their contract and/or speak with their life insurance broker to receive an accurate calculation.

    What happens to cash surrender value when a policy is surrendered?

    When a policyholder surrenders their life insurance policy, they receive the cash surrender value, which is the net amount they are entitled to after the policy’s expenses and deductions are taken into account.

    However, once a policy is surrendered, it cannot be reinstated, and you won’t be eligible for the death benefit.

    How is cash surrender value affected by policy loans?

    Cash surrender value is the amount of money that the policyholder of a life insurance policy can receive if they decide to terminate their policy. It is directly affected by any policy loans which have been taken against the policy.

    When a policy loan is taken out against a life insurance policy, this loan amount is deducted from the cash surrender value of the policy. The amount of the deduction is based on the loan interest rate and the length of time that has passed since the loan was taken out.

    The deduction will also increase if the policyholder has taken more than one policy loan. In this case, additional deductions will be made for each loan.

    The policyholder can reduce the cash surrender value of their policy further by paying additional premiums on their loan. These payments will also reduce the loan’s interest rate, which will lower the total amount deducted from the policy’s cash surrender value.

    How is cash surrender value affected by policy dividends?

    A policy dividend can help increase the policy’s cash surrender value. The total dividend amount allocated is returned to the policyholders in either cash, a reduction in premiums, or a combination of the two. The cash surrender value is increased because the policyholder receives a dividend payment, which is applied to the cash balance of the policy. This results in the increase in the policy’s cash surrender value.

    Furthermore, if an insurance company’s investments perform well due to favorable market conditions or industry trends, policyholders may have access to larger dividends, which in turn will help grow the cash surrender value of their policy.

    Can I withdraw my cash value from life insurance?

    Technically, you cannot withdraw cash values from your life policy (even if it is guaranteed cash value that you are entitled to). But you can access the actual cash value by borrowing against your policy.

    You will pay interest (of 7%-10% annually) each month as you pay premiums, but if you have a large emergency expense, it may be worth it for you to take a lump sum payment of all of your remaining cash value.

    Note that this applies only if you have a whole life insurance policy. You cannot borrow against a term life insurance policy.

    Is cash surrender value taxable?

    The tax treatment of cash surrender value (CSV) depends on the policy cash value itself and the premium payments into the life insurance policy.

    If the surrender value is less than or equal to the amount of premiums paid, then you won’t have to pay taxes, as all of the payments you made had already been taxed.

    However, if the CSV is greater than the premiums paid, the excess amount may be subject to taxation as ordinary income.

    In addition, if the life insurance policy is a Modified Endowment Contract (MEC), the CSV may be subject to taxes and penalties if it is withdrawn or borrowed before the policyholder reaches the age of 59.5.

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