Your life insurance company will offer the guidance you need to surrender your life insurance policy, terminate your coverage, and receive the surrender value.
If you get more money from the insurance company after surrendering your life insurance policy than you paid in premiums, some of that money is considered regular income by the IRS.
For example, if the cash value of your life insurance policy is $14,000 and the insurance company takes $2,500 in surrender fees, you’ll receive $11,500. If you’ve paid $10,500 to the insurance company in premiums over the years, you’ll pay taxes on only $1,000 of the money you received. The IRS considers the other $10,500 a return of premium, which isn’t taxed as income.3
Many life insurance policy owners aren’t aware that they have choices when it comes to their life insurance policy. Your life insurance policy is your legal property, just like anything else you own. You have the right to keep your policy and the death benefit, surrender your policy and claim the cash value, use the cash value to pay the policy’s premiums, or sell the policy through a life settlement if you are eligible and are satisfied with the terms of the settlement.
If you need access to cash but your beneficiaries also need the death benefit provided by your life insurance policy, it’s smart to consider other ways to raise the money. If you need funds to cover outstanding medical bills, don’t create secured debt. Medical bills can eventually hurt your credit, but since they are an unsecured debt, there’s nothing for a medical provider or collection agency to repossess. If you take out a second mortgage to pay off medical bills and then default on your payments, you could enter foreclosure and lose your home.
Depending on the insurance company’s rules and how much money you have in the cash value portion of your life insurance policy, you may be able to take out a loan against your policy’s value.
Since there aren’t any underwriting requirements for a policy loan, it doesn’t matter if you have bad credit. While you will pay interest on the loan, it’s typically less than interest rates on a regular personal loan.
If you have more cash value than required to meet your immediate financial needs and you’d like to keep your life insurance policy in force, talk with your insurance company about making a direct withdrawal from the policy.
The death benefit is reduced dollar-for-dollar by the amount of money you withdraw. You don’t have to pay back the money, though. The death benefit may be less, but it will still be in place for your beneficiaries. Expect to keep paying your regular life insurance premium, even after you make a withdrawal from the policy.4
Americans over the age of 65 forfeit more than $112 billion in life insurance benefits each year by surrendering or lapsing their life insurance policies.5 One way to get some of that money back is to sell your policy through a life settlement. In general, life settlements work best when the insured person is over the age of 65.
While the average cash surrender value paid on a life insurance policy is just 10% of the death benefit, a life settlement offers policy owners an average of 20% of the policy’s death benefit.6
When you sell your life insurance through a life settlement, a group of investors buys the policy for a portion of the death benefit. They take over payment of the premiums, and when you die, the investors receive the death benefit.
You may be able to sell your life insurance policy in a viatical settlement no matter your age if you’ve been diagnosed by a doctor with a serious illness and have a life expectancy of fewer than two years.7 Terminally ill life insurance owners may consider surrendering their life insurance policy if they need quick access to cash. Like life settlements designed for older people, viatical settlements provide the policy owner with more money than cashing in a life insurance policy.
If your policy is 10 to 15 years old, you may have enough money in the savings portion of the policy to surrender it and ask for the money. Your surrender value is the amount of money in the savings portion of your policy, minus the insurance company's surrender fees. During the first few years you own the policy, you'll pay hefty administrative fees to the insurance company. Since those fees are taken directly from your premiums, the policy's cash value may grow slowly at first. It doesn't usually make sense to surrender a policy that's only been in force for a few years. If you still owe administrative fees when you initiate the process of surrendering your policy, those fees come directly out of the cash value. Even after you've paid the insurance company's administrative fees and the cash value of your policy begins to grow, you are still subject to surrender fees if you decide to terminate the policy. The insurance company takes those fees directly out of the cash value before they send you the money. If you've taken loans against your policy and they remain outstanding, the insurance company will also take that money from your policy's cash value. So, you'll receive the cash value of your life insurance policy, minus outstanding loans, administrative fees, and surrender charges when you surrender your whole life insurance policy back to the company.
You may be able to avoid hefty surrender charges if you let your insurance company know that you are thinking about surrendering your policy. Ask if they have a policy that allows them to reduce or eliminate surrender fees if you continue to pay your premiums for a certain amount of time after notifying them of your intent to cancel the policy.8
If you are thinking of terminating your permanent life insurance policy, you may be confused about some of the common terms used by the life insurance company. The surrender value and the cash value of your policy are not the same. Your policy's cash value is the money that accrues inside of the investment portion of your life insurance policy. Life insurance surrender value is your policy's cash value minus the life insurance company's surrender fees. Life insurance companies charge surrender fees if you terminate your policy early. This helps them recoup some of the costs of initiating your policy. It also discourages policyholders from canceling their coverage. The longer you have your policy, the smaller the surrender charges. So, if you've had the same permanent life insurance policy for decades, your surrender value and cash value may be the same.9 Surrendering your life insurance policy makes sense in some situations. However, if you can avoid this often-expensive way to access extra money, you have many options to help you avoid paying surrender fees and administrative fees. In some cases, you may be able to keep your policy in force for your beneficiaries or get much more money by selling your policy through a life settlement.
1 “Consumer Advisors – LISA – Life Insurance Settlement Association.” https://www.lisa.org/consumer-advisors/. Accessed 13 Mar. 2021.
2 “What is a tax-free 1035 Exchange? | Investopedia.” https://www.investopedia.com/ask/answers/09/1035-exchange.asp. Accessed 13 Mar. 2021.
3 “Life Insurance & Disability Insurance Proceeds | Internal … – IRS.” 14 Oct. 2020, https://www.irs.gov/faqs/interest-dividends-other-types-of-income/life-insurance-disability-insurance-proceeds. Accessed 14 Mar. 2021.
4 “Can I Withdraw Money From My Life Insurance? – Experian.” 10 Dec. 2020, https://www.experian.com/blogs/ask-experian/can-i-withdraw-money-from-my-life-insurance/. Accessed 14 Mar. 2021.
5 “Consumer Advisors – LISA – Life Insurance Settlement Association.” https://www.lisa.org/consumer-advisors/. Accessed 13 Mar. 2021.
6 “Consumer Advisors – LISA – Life Insurance Settlement Association.” https://www.lisa.org/consumer-advisors/. Accessed 13 Mar. 2021.
7 “Viatical Settlement Definition – Investopedia.” 19 Feb. 2021, https://www.investopedia.com/terms/v/viaticalsettlement.asp. Accessed 14 Mar. 2021.
8 “Surrender Charge Explained – Investopedia.” 3 Sep. 2020, https://www.investopedia.com/terms/s/surrendercharge.asp. Accessed 14 Mar. 2021.
9 “Life Insurance Cash Value vs. Surrender Value … – Investopedia.” 20 Aug. 2020, https://www.investopedia.com/articles/fa-profession/090816/cash-value-vs-surrender-value-what-difference.asp. Accessed 13 Mar. 2021.