Can I Surrender My Life Insurance Policy?

Surrendering a life insurance policy involves formally ending the contract with your insurance provider before it matures or pays out a death benefit. This action allows the policyholder to receive any accumulated cash value, if applicable, that has built up within the policy over time. Choosing to surrender a policy is a significant decision that impacts future financial protection and can carry financial and tax implications.

Understanding Policy Surrender

Policy surrender refers to the termination of a life insurance contract by the policyholder in exchange for its cash value. This means canceling the insurance coverage, and consequently, beneficiaries will not receive a death benefit upon the insured’s passing. The ability to surrender a policy and receive a cash payout depends on the type of life insurance held.

Permanent life insurance policies, such as whole life, universal life, and variable universal life, accumulate cash value over time. A portion of the premiums paid into these policies contributes to this cash value component, which grows on a tax-deferred basis. In contrast, term life insurance policies do not build cash value because they provide coverage for a specific period without an investment component.

Determining Your Policy’s Cash Value

Policyholders can typically find this information on their annual policy statements, which often detail both the cash value and the cash surrender value. Alternatively, contacting the insurance agent or the insurance company directly provides access to current cash value figures.

The cash value accumulates from a portion of premium payments and any earnings or interest generated by the policy’s underlying investments. Factors influencing the growth of this gross cash value include the amount of premiums paid, the policy’s duration, and for certain types like variable universal life, the performance of chosen investment options. Policy loans taken against the cash value will reduce the available amount, as will any prior withdrawals.

Financial and Tax Considerations of Surrender

A significant financial consideration is the application of surrender charges, which are fees imposed by the insurance company for terminating the policy prematurely. These charges often start higher in the early years of a policy, sometimes 10% to 30% of the cash value, and typically decrease over a period, often 10 to 15 years, eventually diminishing or disappearing entirely.

Any outstanding policy loans, along with accrued interest, will be deducted from the gross cash value before the payout. The actual amount received, known as the net cash surrender value, is calculated by subtracting these surrender charges and any outstanding loans from the policy’s accumulated cash value. For example, if a policy has a cash value of $10,000 but a surrender charge of $1,000 and no loans, the net cash surrender value would be $9,000.

From a tax perspective, the cash surrender value received may be subject to taxation. If the amount received exceeds the total premiums paid into the policy, the excess portion, considered a gain, is generally taxable as ordinary income. The Internal Revenue Service (IRS) views this gain as investment growth, and it is taxed at the policyholder’s applicable income tax rate, not as capital gains. The insurance company typically issues IRS Form 1099-R to report such taxable distributions. The original premiums paid into the policy are generally considered a tax-free return of principal.

The Surrender Process

Policyholders should begin by gathering necessary information, including their policy number and personal identification documents. It is also advisable to locate the original policy document, as some insurers may require its submission.

The next step is to obtain a formal surrender request form from the insurance company, which may be available on their website, through an agent, or by mail. This form typically requires detailed information, including the policyholder’s contact details and instructions for the payout method. After accurately completing and signing the form, it can be submitted to the insurer.

Submission methods often include mailing the original form, though some companies may offer online submission. Upon receipt, insurance companies typically process surrender requests within two to six weeks. The payout, which is the net cash surrender value, is usually disbursed via check or direct deposit.