What Is Cash Surrender Value and How Does It Work?

Life insurance policies with a cash value component allow policyholders to build savings over time, but those savings can also be accessed if the policy is canceled or lapses. The cash surrender value of life insurance is the amount available to the policyholder after surrendering the policy, typically equal to the accumulated cash value minus any fees or outstanding loans. Because this value changes over time and may be subject to taxes in certain cases, it plays a significant role in how policyholders evaluate their options.

It can be advantageous to work with a financial advi s or as you decide upon your insurance strategy.

What Is the Cash Surrender Value?

When a cash value life insurance policy is canceled or lapses, the insurer pays out what’s known as the cash surrender value. This figure is based on the accumulated cash value of the policy, reduced by any surrender charges, administrative fees or outstanding loans taken against it.

Over time, cash value tends to build as premiums are paid and interest accrues, which means policies held for many years often generate a higher surrender value. For some policyholders, this account growth can serve as an additional savings resource while the coverage remains in place.

How Does Cash Surrender Value Work?

What Is Cash Surrender Value and How Does It Work?

Cash value life insurance policies such as whole life, universal life and variable universal life gain cash value over time. This amount accumulates as policyholders pay their premiums because these payments go toward the death benefit protection, the fees and costs of the policy and the cash value of the account.

The cash value can accumulate in different ways based on the type of policy a person owns. For example, some whole life insurance policies receive dividends that can increase the cash value of the policy. Universal life insurance policies, meanwhile, pay an interest rate that increases the cash value. Variable universal policies invest portions of the premiums into mutual fund accounts that can boost the cash value of a policy.

Regardless of how the cash value is generated, it is designed to grow over time. The longer a person holds their life insurance policy, the higher the cash value will be.

Then, if someone chooses to cancel their policy, the cash value will be a major determining factor in the cash surrender value. The cash surrender value is determined by first evaluating what the cash value of the policy is, then subtracting any fees that the insurer will charge to liquidate the policy. Some companies will charge a flat fee or a percentage of the total cash surrender value. The cash surrender value also reflects any outstanding loans taken against the cash value.

It is important to note that the cash surrender value will always be less than the cash value, and significantly less than the policy’s face value.

Most of the time, the cash surrender value will be tax-free up to the dollar amount of premiums that a policyholder has made. However, if the cash value of a life insurance policy earns dividends and interest, that income may be taxable.

Alternatives to Surrendering a Life Insurance Policy

There are alternatives to surrendering a life insurance policy. Depending on your current financial standing and future financial goals, the following options might be a better solution.

Withdraw the Cash Value

One alternative to surrendering a life insurance policy is to withdraw the cash value. This option is available as long as there are funds in the cash value of the policy. It’s important to note that it will be tax-free up to the amount that you have contributed to the cash value.

For example, let’s say that you have had your whole life insurance policy for 15 years and you have contributed at least $1,000 per year to the cash value. Assume the cash value has accumulated $1,000 in dividends, bringing the total to $16,000. You could borrow $15,000 tax-free and would only pay taxes on the $1,000 that you earned in dividends.

This is a good option for someone who wants to continue paying their premiums but needs to access their cash reserves.

Use the Cash to Pay Premiums

If you do not have the cash to make your monthly premiums but want to keep your life insurance in effect, you could use the cash value to pay your premiums. This is a good option for someone strapped for cash on a monthly basis but who still wants to protect their beneficiaries’ financial health in the long run.

Many policies allow premiums to be paid from the cash value, either temporarily or permanently. The ability to pay premiums with a cash value depends on the amount of cash value available. For example, if the policy has only been in effect for a few years, the cash value might only be large enough to cover several months’ worth of premiums. However, this might be long enough for a policyholder to get back to a point at which they can afford their monthly premium payments.

When a disability or permanent injury makes it hard to keep up with premiums, some policies include a disability rider that can step in. This provision waives premium payments when the policyholder is unable to work and ensures that coverage remains active.

Sell Your Insurance Policy

A third alternative is to sell your insurance policy to a life settlement company. If you no longer need your life insurance policy, you might be able to get more money by selling your policy than by simply surrendering it. This is a good option for people who no longer need their life insurance but do want to access as much of their cash value as possible.

To sell your policy, you will first need to contact a licensed life settlement company. Then, they will give you an offer on your life insurance policy based on the policy, your age and your overall health. Your goal as a policyholder will be to receive a cash payment that is larger than the cash surrender value offered by your insurer. It is important to note that this amount will always be less than the death benefit of your policy.

If you choose this option, you should know that the policy will remain in effect, but you will be transferring ownership. The purchasing company can change the beneficiary, assume premium payments and collect the death benefit upon the insured’s death.

Bottom Line

If you are looking for ways to access cash without taking out debt, you might think that surrendering your life insurance policy is the best way to do so. However, surrendering your policy will mean that you no longer have a death benefit that can be valuable for beneficiaries. Surrendering a policy also reduces the cash value due to fees and taxes. Therefore, you might want to consider the alternatives to help you access your cash and keep your policy in place.

Insurance Planning Tips

Your selection of an insurance policy can have lasting effects on your overall finances, especially once you reach retirement. If you’re unsure of which policy to go with, a financial advisor may be able to help. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Looking for a quick way to see how much insurance you need to buy? Use SmartAsset’s free insurance tool. It is always a good idea to speak with a financial advisor before making a decision that will impact you and your family’s financial futures.