What Is a Cash Surrender on a Life Insurance Policy?

Life insurance policies can provide financial protection for beneficiaries, and some types offer an additional feature: cash value accumulation. This accumulated cash value can become a valuable asset during the policyholder’s lifetime. Understanding how to access this value, particularly through a process known as cash surrender, involves knowing its definition, calculation, the procedural steps, and potential tax implications.

What is Cash Surrender Value

Cash surrender value represents the amount of money a policyholder receives when they choose to terminate a permanent life insurance policy before the insured event occurs or the policy matures. This amount differs from the policy’s cash value, which is the total sum accumulated in the policy’s internal cash account. The cash surrender value is the cash value minus any applicable surrender charges or outstanding policy loans.

Cash value typically builds over time from a portion of the premium payments, accumulating on a tax-deferred basis. This feature is exclusive to permanent life insurance policies, such as whole life, universal life, variable universal life, and indexed universal life. Term life insurance policies, by contrast, are designed solely for death benefit protection over a specific period and do not accumulate cash value, therefore they do not have a cash surrender value.

For whole life policies, the cash value often grows at a fixed interest rate, sometimes supplemented by dividends. Universal life policies, however, may have cash value growth tied to current interest rates or market performance, offering flexibility but sometimes higher fees. The surrender value is influenced by how long the policy has been in force, with surrender charges often diminishing or disappearing after 10 to 15 years.

Calculating Cash Surrender Value

The calculation of a life insurance policy’s cash surrender value involves several components, reflecting the interplay of premiums paid, policy charges, and investment performance. The cash value itself typically grows as a portion of each premium payment is allocated to a savings component, earning interest or investment returns. The longer a policy has been maintained, the greater its cash value tends to be.

Key factors influencing this accumulation include the amount of premiums paid, the policy’s interest crediting rate, and any dividends for participating policies. However, various fees and charges are deducted from the cash value, which impact the final surrender amount. These can include mortality charges, which cover the actual cost of insurance based on age and health, and administrative fees for policy maintenance.

Premium loads or sales charges may be deducted from premium payments before they contribute to the cash value. Surrender charges, which are fees imposed for terminating the policy early, also directly reduce the cash surrender value. Any outstanding policy loans, including accrued interest, are subtracted from the cash value to determine the net cash surrender value payable to the policyholder.

The Surrender Process

Initiating the surrender of a life insurance policy to receive its cash value begins with contacting the insurance provider directly. Policyholders can reach out to their insurer by phone, email, or mail to express their intent to surrender the policy.

The next step involves requesting and completing the necessary surrender forms. These forms are available on the insurer’s website, or they can be mailed to the policyholder. The surrender request form requires accurate completion, asking for details such as the policy number and personal identification information.

Once the form is filled out, it must be submitted to the insurance company, which allows submission via mail, an online portal, or in-person at certain locations. After submission, the insurer reviews the request, and processing times range from 7 to 30 business days. Upon approval, the cash surrender proceeds are disbursed to the policyholder by check or direct deposit, along with a confirmation that the policy has been terminated.

Taxation of Cash Surrender

Receiving the cash surrender value from a life insurance policy can have tax implications, concerning any gain realized from the surrender. A “taxable gain” occurs when the cash surrender value received exceeds the policyholder’s “cost basis.” The cost basis represents the total premiums paid into the policy, reduced by any prior tax-free withdrawals or dividends received.

Only the amount of the cash surrender value that exceeds this cost basis is considered taxable income. This gain is taxed as ordinary income, not as capital gains, and can increase the policyholder’s tax liability for the year. For example, if a policyholder paid $20,000 in premiums and receives a cash surrender value of $30,000, the $10,000 gain is taxable.

When a taxable gain is realized, the insurance company is required to issue Form 1099-R, “Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.,” to the policyholder. This form reports the gross distribution and the taxable amount. If the cash surrender value does not exceed the cost basis, the distribution is tax-free.