What Happens When You Surrender a Policy for Cash Value?

Life insurance policies that accumulate cash value, such as whole life or universal life, offer a savings component in addition to a death benefit. This cash value grows over time on a tax-deferred basis, providing a potential financial resource during the policyholder’s lifetime. Policyholders can access these accumulated funds through withdrawals, policy loans, or by surrendering the policy. Surrendering a policy means canceling the coverage in exchange for its cash value.

Initiating the Surrender

Contacting the issuing insurance company initiates the surrender process. This can be done via phone, online portal, or written request. The insurer will then provide the necessary forms and instructions.

Upon receiving the forms, policyholders must gather specific information and documentation. Required items include the policy number, personal identification, and bank account details for direct deposit. The original policy document may also be needed.

It is important to complete the surrender form accurately, ensuring all requested details are provided. Any missing or incorrect information can lead to delays in processing the request. Submit the form and supporting documents to the insurer, often by mail or secure online portal. The insurance company confirms receipt and may provide an estimated processing timeline.

Determining Your Cash Payout

The amount received upon surrender is the “net surrender value” or “cash surrender value,” which differs from the policy’s accumulated cash value. The cash value includes premiums paid and earned interest or dividends.

The cash surrender value is determined by subtracting charges and outstanding balances from the gross cash value. Surrender charges are fees applied by the insurer to recoup initial costs, especially if surrendered early. These charges decrease over time and may disappear entirely after a certain period, often 10 to 15 years. The surrender charge can be a percentage of the cash value, potentially reducing the payout.

Outstanding policy loans and accrued interest are deducted from the cash value. Prior cash withdrawals also reduce the amount received. The final surrender value is calculated as of the date the complete request is received. Policyholders can expect to receive the funds within a few weeks after the surrender is finalized, typically via check or electronic transfer.

Tax Consequences of Surrender

Surrendering a life insurance policy for its cash value can have tax implications, as any “gain” on the policy is taxable income. Taxable gain is the net surrender value minus the policyholder’s “cost basis,” which is the total premiums paid, reduced by tax-free dividends or prior withdrawals.

Any taxable gain is treated as ordinary income, subject to the policyholder’s marginal income tax rate. If the net surrender value is less than the cost basis, resulting in a loss, this loss is not tax-deductible.

The insurance company reports the taxable distribution to the policyholder and the Internal Revenue Service (IRS) on Form 1099-R. This form details the gross distribution and taxable amount. Policyholders receive this form in the year following the surrender.

A different tax treatment applies if the policy is a Modified Endowment Contract (MEC). If a policy becomes a MEC, distributions, including surrenders, are subject to “last-in, first-out” (LIFO) taxation, meaning gains are taxed first. Additionally, distributions from a MEC before the policyholder reaches age 59½ may be subject to a 10% penalty tax, unless an exception applies.

Cessation of Policy Benefits

Surrendering a life insurance policy immediately terminates the insurance coverage. The death benefit associated with the policy is no longer in force, meaning beneficiaries will not receive a payout upon the policyholder’s death.

The policy also ceases to accumulate cash value or earn any further interest or dividends. The primary purpose of life insurance is to provide financial protection to loved ones through a death benefit, and surrendering the policy removes this financial safety net for beneficiaries.