What Happens When You Surrender a Whole Life Policy?

When a whole life insurance policy is no longer needed or affordable, policyholders might consider surrendering it. Surrendering a policy means voluntarily terminating the contract with the insurance company before its maturity date or the insured’s death. This option is explored by individuals who no longer require the death benefit or need access to the policy’s cash value for immediate liquidity.

Calculating Your Payout

The amount a policyholder receives when surrendering a whole life insurance policy is known as the cash surrender value (CSV). This figure is distinct from the policy’s face value (the death benefit) or its cash value (the total accumulated savings component). The CSV is the sum paid out by the insurer after accounting for various charges and outstanding obligations.

The cash value within a whole life policy grows over time, accumulating from premium payments and any dividends earned. This growth is typically more significant in the later years of the policy, as the cash value compounds. When a policy is surrendered, the insurer calculates the cash surrender value by taking the policy’s total cash value and subtracting any applicable surrender charges and the balance of any outstanding policy loans.

Surrender charges are fees imposed by the insurance company for early termination of the policy. These charges exist to help the insurer recoup the initial costs associated with issuing the policy, such as underwriting and agent commissions. The structure of these charges often declines over a specified period, commonly ranging from 7 to 15 years. For instance, a surrender charge might start at 10% or more of the cash value in the first year and gradually decrease, potentially reaching 1% or even zero after ten or more years.

For example, if a policy has a cash value of $10,000 and a 10% surrender charge applies, $1,000 would be deducted. Additionally, any outstanding policy loans, including accrued interest, will directly reduce the amount received. The net payout is the final amount the policyholder actually receives after all these deductions are applied, which can be considerably less than the stated cash value, especially in the early years of the policy.

Tax Consequences of Surrendering

When a whole life insurance policy is surrendered, the payout received can have tax implications. The Internal Revenue Service (IRS) generally considers any gain on the surrender of a life insurance policy as taxable income. This gain is calculated by comparing the net cash surrender value received against the policyholder’s “cost basis.”

The cost basis of a life insurance policy is typically defined as the total amount of premiums paid into the policy, reduced by any dividends that were received in cash or used to lower premium payments. For tax purposes, the portion of the cash surrender value that equals the cost basis is generally received tax-free.

A taxable gain occurs if the net cash surrender value received exceeds this cost basis. This difference, the amount by which the payout surpasses the total premiums paid (less any dividends), is generally taxed as ordinary income, not as capital gains. For instance, if a policyholder paid $50,000 in premiums and receives a cash surrender value of $65,000, the $15,000 difference would be considered a taxable gain.

If the surrender results in a loss (net cash surrender value is less than the cost basis), such a loss is typically not tax-deductible. Furthermore, if the policy had outstanding loans that are forgiven upon surrender, the amount of the forgiven loan may also be considered taxable income. Insurers will often issue a Form 1099-R to report the distribution from the policy, detailing any taxable portion.

Steps to Surrender Your Policy

Contacting the insurance company directly is the first step to surrendering a whole life insurance policy. This can be done by phone, through their online portal, or by speaking with an insurance agent. The insurer will provide specific instructions and outline the necessary documentation required to process the surrender request.

Policyholders need to complete a formal surrender form provided by the insurance company. This form may be available for download on the insurer’s website or can be requested by mail. Along with the completed form, the insurer may require additional documents such as the original policy contract and proof of identification to verify the policyholder’s identity.

Submission methods may include mailing the physical documents, online submission, or in some cases, in-person delivery. Some surrender forms may also require notarization to ensure authenticity, so it is important to review the specific instructions carefully.

After submission, the insurance company will begin processing the request. The processing time can vary but ranges from a few business days to several weeks (two to six weeks). Upon successful processing and policy termination, the payout is disbursed to the policyholder via check or direct deposit.