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One of the benefits of a cash value life insurance policy is that you can access the money while you’re still alive. There are several ways you can take money out from 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 in Life Insurance
If you have a permanent life insurance policy, it likely has a cash value component. There are several ways that you can access that money as the policyholder.
Withdrawal
You have the option to withdraw funds from the cash value portion of your policy. As long as you withdraw only up to the amount you’ve paid in premiums (known as the cost basis) and not the gains you’ve earned, you won’t owe taxes. You can withdraw more than the cost basis, but be prepared to pay taxes on that portion.
A withdrawal from cash value will reduce the death benefit that your beneficiaries receive.
Policy loan
You can also borrow against your policy’s cash value. There is no loan application process or credit check involved because you are essentially borrowing from yourself. You do need to pay interest, but rates are typically low.
If you die before the loan is repaid, the outstanding balance is deducted from the death benefit paid to your beneficiaries.
Surrender
Surrendering a life insurance policy means canceling the policy and receiving its surrender value, which is the cash value minus any surrender fees. If you go this route, the coverage ends. Your beneficiaries will not receive a death benefit when you die.
You’ll owe taxes on the amount you receive that’s above the cost basis.
Life settlement
If you no longer want or need your policy, you can sell it to a third party in what’s known as a life settlement. You receive a one-time cash payment, often for more than the surrender value (more on that later). The buyer assumes responsibility for the policy, including making the premium payments, and receives the death benefit when you die.
Life settlements are generally intended for older people who are in declining health.
When to Surrender Your Life Insurance Policy
Considering the various ways to access your cash value in life insurance, you might be wondering when it’s best to surrender your policy for cash. Here’s a look at some scenarios when this may make sense.
You found a better deal
Although life insurance quotes rise with age—and new health issues you develop—there’s a chance that you’re able to qualify for a more affordable policy today versus when you first took out your current one. For example, maybe 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-force before surrendering your current policy. Also, before buying new life insurance, look into whether a 1035 exchange could save you money on taxes.
You can’t afford the premiums
Permanent life insurance is significantly more expensive than term life insurance. If the premiums are taking a big bite 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 simply may no longer need life insurance coverage. For example, if no one depends on you financially anymore, you may not need life insurance. It may not make financial sense to keep your policy in-force.
You need a large amount of cash quickly
If you have a major expense to cover or maybe a better investment opportunity but don’t have any liquid assets to tap, surrendering a cash value life insurance policy may be a decent option, especially if your actual need for life insurance has diminished.
How to Is Cash Surrender Value Calculated?
The surrender value of a policy is based on the portion of premiums that went into the cash value account plus the interest rate paid or investment gains. From that, outstanding loans are subtracted, along with any surrender fee.
Some policies take many years to build up any substantial cash value, so you might not have much cash value anyway.
Over time, surrender fees tend to decrease. Ideally, you would wait until the fee is minimal or nonexistent. Plus, the longer you’ve held the policy, the larger the cash value portion will likely be.
Also, remember that if your cash surrender value is worth more than you’ve paid in premiums, you will need to pay income taxes on the difference.
Finally, keep in mind that your beneficiaries won’t receive a death benefit if you surrender your policy. So when exploring your options for taking cash value from life insurance, consider how each method will impact your long-term estate planning and goals. There may be a better option if you need cash.
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Surrendering Life Insurance FAQ
Can you surrender a term life insurance policy?
You can cancel a term life insurance policy anytime, but since there is no cash value component included in term life, there’s no money to get back.
What is a 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. It is the cash value you have minus any surrender charge. Surrender charges can last about 10 to 15 years after you buy the policy.
Will I pay taxes on the cash surrender value?
If the cash surrender value you receive is higher than what you’ve paid in through premiums (cost basis), you can be taxed on the amount that is over what you’ve paid. Speak with a tax professional to determine when life insurance is taxable.
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