What Happens When You Surrender a Life Insurance Policy?

Did you know you can sell all or a portion of a life insurance policy, even term insurance?

(5 minute read)

For one reason or another, sometimes people find themselves with life insurance policies they no longer want or need. The premium may be too high, or the policy may simply be underperforming, or the need for the policy just isn’t there anymore. Regardless, these policies can become a burden when other, more lucrative investment opportunities present themselves. For this reason, many people simply surrender their policies when the need arises. But what does that mean, and are there other options?

What happens when you surrender a life insurance policy?

Different types of policies have varying outcomes when it comes to surrendering, but in general, by surrendering your policy, you’re agreeing to take the cash surrender value that the insurance company has assigned to your policy, and in return, forgoing the death benefit. 

Whole and universal policies accrue cash value, making them the most likely option for surrender. Depending on the type and age of the policy, they may have accrued a significant amount of cash value—or not very much at all. The reason some people surrender a life insurance policy for the cash value is because it rids you of the burden of a monthly premium and potentially nets a fair amount of money for other investments or necessities.

There are two caveats to surrendering a policy, however. First, if your policy isn’t very old, you may incur surrender fees which will lessen the amount of cash you receive. Second, the gain on your policy—however much it may be—will be taxed as income. Death benefits are tax-exempt, but the cash you receive from surrendering is taxable. Consult your tax professional before making any decisions.

Let’s look at what happens when you surrender a whole life settlement. Surrendering a whole life insurance policy means you are cancelling the policy. Instead of your beneficiaries receiving the death benefit, you as the policyholder will receive the cash value your whole life insurance policy has built up over time.

This can be an appealing prospect, especially if you no longer need the coverage of the policy to make sure outstanding debts like a mortgage or other loans are paid off. But this decision can also cause you to lose out on a significant amount of return on your investment in the policy. Examining all the angles of how this decision can impact your financial future is important before you decide.

Commonly asked questions about life insurance vocabulary

When discussing life insurance, there are some terms that are easily confused. Some people may wonder what is the difference between cancellation and surrender of an insurance policy? The answer is that cancelling and surrendering an insurance policy are the same thing. 

Another common question is, what is the difference between cash value and surrender value of life insurance? Unlike cancellation and surrendering, these are not the same thing. Cash value or account value is the sum of the money you paid for the policy, and surrender value is money you get back from the life insurance company after fees.

Can you surrender a term life insurance policy?

Yes, you can, but the reality is that your term life insurance policy won’t have any cash surrender value. Surrendering a term policy essentially means removing the monthly premium from the budget, but unfortunately, not much else.

Can you cash out a whole life insurance policy?

Yes, a whole life insurance policy can be cashed out in several ways, from small benefits to large benefits.

Some policy holders are able to stop making premium payments and instead set it up so that the monthly premium payments are paid out of the cash value of the policy. This means you gain back the cash every month you were using to make the payments, but it also reduces the value of the policy long-term.

Another option is a loan from the whole life insurance policy. This means you borrow a certain amount from the insurance company and use the life insurance policy as collateral. These loans do often accrue interest, and unless you pay that interest out-of-pocket, it will later be deducted from the death benefit of the policy.

Instead of a loan, you could choose to take a withdrawal from the whole life policy. The terms of your ability to take a withdrawal will be spelled out in the insurance agreement. Usually, you can take a withdrawal up to the amount of premiums you have paid into the policy. Later, this amount is also deducted from the death benefit.

These options all allow you to maintain the whole life policy. There is also the option of surrendering the policy as we discussed earlier. This means you will receive the cash value of the policy, after any surrender fees that are charged by the insurer, and the policy will be cancelled.

When should you surrender life insurance?

It will vary depending on the type of policy you have. For example, you should only consider cashing out, i.e. surrendering, a whole life insurance policy after you have held it long enough to minimize the surrender fees. In the first few years of holding a whole life policy, you may not be able to cash it out at all. And if you do, you can be charged 10% or more of the cash value in fees. After ten or more years of holding the policy the surrender fees often go down to 1% or may not be charged at all. It’s important to review your policy documents carefully to understand the fees that may come along with the timing of cashing out the policy through a surrender. You should also examine how taking a loan or withdrawal will reduce the benefits if you are considering those options.

How do I find the cash value of my life insurance policy?

If you’re wondering how to calculate the cash value of a life insurance policy, there unfortunately is not an easy answer. Your cash value will be unique and will be influenced by your premium payments, insurer policies, the type of policy, and any loan balances. You can contact your issuing company to find what your cash value is.  

Why would I surrender my life insurance policy?

Unexpected costs are always lurking around the corner, and that is especially true for those in retirement. Without a dependable source of income, seniors often need to heavily budget their savings to make it last; unfortunately, if something were to happen, this could leave an individual or couple in dire financial straits. Some reasons to surrender a policy are:

• Unforeseen medical expenses, such as surgery, injury, or the need for long-term care.
• Sudden repairs for a house, perhaps caused by an accident or faulty work.
• Unneeded coverage as one’s life changes; as children move out and become financially independent or a marriage ends due to divorce or death, a life insurance policy may not be needed to ensure next of kin are supported.
• Less expensive coverage found after comparison shopping; with the many online tools for finding the cheapest and most effective insurance plan, it’s common to find that you have been paying too much for coverage you may find from another provider.

What are the tax consequences of surrendering a life insurance policy?

In terms of tax on the surrender of a life insurance policy, it actually is not viewed much differently from regular income, so it’s subject to a marginal rate of taxation. If a policy ends after 20 or more years, the cash return is likely to be much higher. However, if the policy has only been in place for 10-15 years or less, your provider may issue surrender fees, similarly to if you were to pull out of an investment. If you’re unsure about these fees, your broker will be able to set expectations and let you know where your policy currently stands.

Cancelling a life insurance policy you no longer want or need can be an excellent way to put extra cash in your pocket. You may need this money for cost of living increases or even to fund a long-dreamed of vacation.

For example, let’s look at the tax implications of cashing out a whole life policy for you as the policy holder. When you cash out the whole life policy the money you receive in return may be taxed over a certain threshold.

If you paid $10,000 in premiums over the time you held the policy, the first $10,000 you receive back from the surrender will not be taxed. But any payout you receive greater than the premiums you paid will be taxed as ordinary income at your top tax rate. If you receive a payout from investments in the policy that is greater than the policy’s cash value assigned by the insurer, that will be taxed as capital gains. If you are planning to surrender a whole life insurance policy it’s very important to consult with a tax professional and understand these implications for your finances.

Can I sell my whole life insurance policy?

Rather than surrendering your life insurance policy, there is another way to even further maximize this source of income: a life settlement. Did you know you can sell all or a portion of your life insurance policy, even term insurance?  Working with the experts at Life Settlement Advisors, you can actually find a buyer for your life insurance policy and get as much as 4-8 times the cash surrender value.

Selling a whole life insurance policy in a life settlement is a strategy to get far greater returns than a surrender. On average,every $100,000 in life insurance policy value will only gain back $460 in surrender value. This means even a $1 million whole life policy will be surrendered for around $4,600 in cash. Depending on how long you have held the policy, this may not even cover the investment you have made through premium payments. By comparison, a life settlement pays out an average of 22% of the policy’s face value. The same $1 million whole life policy would be sold in a life settlement for $220,000 or more, over 50x more than the cash gained by surrendering the policy. Additionally, you can sell only a portion of the whole life policy. This allows you to gain cash now while also maintaining some of the investment for your beneficiaries.

Case Study: Ann divorced many years ago and had been holding on to her life insurance policy until her children graduated from college and obtained good jobs. She asked her financial advisor, “Can I sell my life insurance policy?” Ann’s financial advisor informed her that she could sell all or a portion of her life insurance policy, even term insurance. Ann sold her policy for $155k and used the money to help fund her grandkids’ college educations.

Life Settlement Advisors dedicates our business to helping individuals achieve greater returns on their life insurance because we know how valuable these investments are to policyholders. The decision to cash out a whole life insurance policy doesn’t have to mean taking a loss on years of investment. A life settlement empowers the policy holder to sell their part of all of their whole life insurance as an asset the same way they would sell a car, house, or stocks and bonds.

Life settlements may not work for everyone, but they’re a valuable option that many people don’t consider. If you or a client has a life insurance policy you’re planning to surrender, consider a life settlement. It might provide you with a valuable alternative. You can see if it’s a good fit by using our qualification calculator.

Leo LaGrotte
Life Settlement Advisors
llagrotte@lsa-llc.com
1-888-849-0887