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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 still alive. There are several ways to get money out of 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 the cash value of life insurance
If you have a permanent life insurance policy, it likely has a cash value component. There are several ways to access this money as a policyholder.
You have the option to withdraw funds from the cash value portion of your policy. As long as you only withdraw the amount you paid in premiums (known as your cost basis) and not the earnings you earned, you won’t have to pay tax. You can withdraw more than the cost basis, but be prepared to pay taxes on that portion.
A cash value withdrawal 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 basically owed a loan. You have to pay interest, but the rates are usually low.
If you die before repaying the loan, the outstanding balance is deducted from the death benefit paid to your beneficiaries.
To give up
Surrendering a life insurance policy means canceling the policy and receiving its surrender value, which is the cash value minus surrender charges. If you go this route, coverage ends. Your beneficiaries will not receive any death benefits when you die.
You will have to pay taxes on the amount you receive above the cost basis.
If you no longer want or need your policy, you can sell it to a third party in what is known as a life settlement. You’ll receive a one-time cash payment, often for more than the redemption value (more on that later). The buyer assumes responsibility for the policy, including paying the premium, and receives the death benefit when you die.
Living settlements are generally intended for seniors who are in poor health.
When to surrender your life insurance policy
Considering the different ways to access your cash value in life insurance, you may be wondering when it’s best to surrender your policy for cash. Here’s a look at some scenarios where this might make sense.
You found a better deal
Although life insurance quotes increase with age, and new health issues you develop, there’s a chance you may qualify for a more affordable policy today compared to when you first took out your current For example, maybe your health has improved significantly or you’ve stopped smoking.
In this case, it is worth buying a new one at a lower cost. Make sure your new policy is in effect before you surrender your current policy. Also, before you buy new life insurance, see if 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 premiums are taking a big bite out of your income, you might be better off with a cheaper term life policy. Consider buying term life insurance to compare costs.
You no longer need life insurance
There are some cases where you simply don’t need life insurance coverage anymore. For example, if no one is already financially dependent on you, 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 perhaps a better investment opportunity, but don’t have any liquid assets to draw on, surrendering a cash value life insurance policy can be a decent option, especially if your real need to ‘life insurance has decreased.
How is the cash surrender value calculated?
The surrender value of a policy is based on the portion of the premiums that went into the cash value account plus the interest rate paid or investment earnings. From this, outstanding loans are subtracted, along with any delivery fees.
Some policies take many years to build up substantial cash value, so you may not have much cash value anyway.
Over time, delivery fees tend to decrease. The ideal would be to wait until the quota is minimal or non-existent. Also, the longer you have the policy, the higher the cash value portion is likely to be.
Also, remember that if your cash surrender value is worth more than what you paid in premiums, you’ll have to pay income taxes on the difference.
Finally, keep in mind that your beneficiaries will not receive any death benefits if you surrender your policy. So, when exploring your options for taking the cash value of life insurance, consider how each method will affect your long-term wealth planning and goals. There may be a better option if you need cash.
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Frequently asked questions about surrendering life insurance
Can you surrender a term life insurance policy?
You can cancel a term life insurance policy at any time, but because there is no cash value component included in term life, there is no money to get back.
What is a cash surrender value?
The 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’s the cash value you get minus any delivery charges. Surrender charges can last for 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 more than what you paid through premiums (cost basis), you can tax the amount that exceeds what you paid. Talk to a tax professional to determine when life insurance is taxable.