Certain permanent life insurance policies offer lifelong coverage and also bundle as an investment tool.
A portion of each premium goes toward covering the cost of insuring your life, while the other part is routed to a built-in investment account, called cash value. This account earns interest and grows on a tax-deferred basis.
You can access your monetary value whenever needed and withdraw it completely by cancelling your life insurance policy. This can be useful if you need immediate payments to pay off your mortgage or debt to the bank, or if you prefer not to use your investments or assets as collateral for outstanding loans. The amount you receive when terminating a permanent life insurance policy is called cash surrender values.
Continue reading this article to find out how they are calculated and whether cash value life insurance is right for you.
What is cash surrender value?
Many permanent life insurance policies include a savings component (located in a separate savings account), called the cash value. When you surrender such a policy, the insurance company pays you a certain amount of money, referred to as the cash surrender value. In this context, “surrender” means cancel, terminate, or return.
The insurer uses the following formula to determine how much money it owes you at the time of cancellation:
The cash surrender value = the cash value minus the surrender fee.
In the first few years, surrender fees can be as high as 35% of the cash value. After ten or 15 years, the surrender charge often whittles down to just 1% or is not applied at all.
It's important to note that the cash surrender value is taxable. However, you won't be taxed on the entire surrender value. Instead, you will get a tax bill only for the amount that exceeds the policy basis, which represents interest or investment gains like dividends or capital gains. The policy basis is the part you've paid in life insurance premiums.
What Types of Life Insurance Have Cash Value?
Life insurance products are either term or permanent. A term life insurance policy lasts for a specific term or until a specific age. The insurer pays out only if the life insured or company insured passes on during the policy term. Term life insurance plans do not build cash value.
Permanent life insurance policies last for your entire lifetime, as long as you make the premium payments. Permanent life insurance products are further divided into various sub-types, and only two of them — whole life and universal life — accumulate cash value.
Whole life insurance
Whole life insurance policies last as long as you do, have level premiums, and promise guaranteed benefits. The cash value grows at a fixed rate determined by the insurance company, and you can use it for any purpose. For example, you can use it to pay the down payment on a house, pay for your child’s college tuition fees, or fund a new startup.
The cash value of a permanent life insurance or whole life insurance policy is frequently divided into two parts: guaranteed cash value and dividend cash value. The guaranteed cash value can be obtained by surrendering the insurance or borrowing against the policy. The dividend value, only found in participating whole life plans, can be withdrawn by surrendering the policy or taking a loan.
Typically for whole life insurance plans, the policy is designed to endow at maturity of the contract, which means the cash value equals the death benefit. If the insured lives to the maturity date, the policy will pay the cash amount in a lump sum to the owner.
Universal life insurance
Universal life insurance policies are also permanent life insurance and accumulate cash value based on current interest rates. However, they offer more flexibility with the premiums and death benefits.
There are three types of universal life insurance plans:
- Guaranteed universal life: These life insurance policies have little or no monetary value and the premium payments and the death benefit are fixed.
- Indexed universal life: These life insurance policies may allow you to vary the premiums and death benefits, within predefined limits. The cash value is tied to a market index, so the rate of return is not fixed. If the stock market is having a good run, your cash amount will grow at a faster rate. However, there is a maximum percentage you can gain, regardless of how well the market performs. And if the market drops, your cash value will grow at a minimum return rate, which can be as low as 0%. In other words, with indexed universal life insurance policy, both your cash value’s upside and downside are capped.
- Variable universal life: These life insurance policies allow you to vary the premiums and death benefits, within limits. The cash value is tied to sub-accounts selected by you, so you enjoy a certain level of control over how it grows. Smart investment choices can generate handsome returns on the monetary value. But the cash amount can also get wiped out completely if you make poor investment decisions. Variable universal policies are more complex than other types of universal plans and have higher fees.
Should I Buy Insurance With Cash Value?
Deciding if life insurance with cash value is right for you depends on your financial situation and long-term goals.
The most advantageous aspect of such a policy is that you get to accumulate wealth on a tax-deferred basis. Cash value life insurance offers a lower interest rate than traditional investment vehicles. Also, any unused monetary value at the time of your death usually reverts to the insurance company.
For most people, term life insurance is enough. It is cheaper and easier to understand. Some policyholders may prefer another type of insurance coverage. But if you have maxed out your retirement funds, have a sizable emergency fund, and can commit to a long-term contract, life insurance with cash value can be a good option. Even then, it would be best to speak to a trusted life insurance expert first.
For those facing illness or disability, an option instead of life insurance with cash value is to pursue an insurance claim for financial compensation. If you are heading into retirement, you could look into setting up an annuity with life insurance companies to provide protection to you and your loved ones. If you don't have access to a workplace retirement account, you could also look into an Individual Retirement Account (IRA). These alternatives address your urgent financial needs and can be beneficial during a financial crisis.
Cash Value vs Cash Surrender Value
Cash value refers to the sum of money that builds up in the investment-component of permanent life insurance policies. This money grows on a tax-deferred basis, at either fixed or variable rates, and can be tapped into anytime you want. You, the policy owner, can make withdrawals or take a loan against your policy’s cash value for any purpose and use the funds however you like.
The monetary value is for the policyholder (or policyholders) to use during their lifetime. Upon the insured’s death, unused cash value generally reverts to the insurance carrier, including the guaranteed cash value. Beneficiaries receive only the death benefit.
Cash surrender value, also known as policy surrender value, refers to the sum of money you receive when you surrender (cancel) your life insurance policy. Cash surrender value is equal to the cash value minus surrender fees. If there are no surrender fees, which may happen after you have had the policy for a long time, the cash surrender value is the same number as the cash value. However, in most cases, the cash surrender value is less than the cash value.
How to Determine Cash Surrender Value
To determine the cash surrender value at any given time, you must find out two things: the actual cash values and the surrender charges. The cash surrender value is the difference between the two.
Charges are pricier for new policies due to surrender fees, but become less expensive over time. During the first policy years, they can be as high as 35% of the cash value. Since cash value grows very slowly during the first few years before picking up the pace, you may receive little or no surrender value if you surrender your policy soon after purchasing it.
For example, let's say you have a seven-year-old insurance plan that has a cash value of $50,000. You want to surrender it in return for its cash value and the surrender charge amounts to 10% of the cash value. This means the cash surrender value you will receive is $45,000. The insurance company will keep the remaining $5,000.
What is a Surrender Fee?
Surrender fees or surrender charges are the costs associated with canceling a cash-value permanent life insurance policy. The insurance company imposes surrender fees to recover its expenses in setting up the life insurance contract.
The surrender fee is a percentage of the accumulated cash value and varies depending on the age of the policy. When you cancel a policy, the insurer takes out the surrender fee from the cash value and you receive the remaining amount.
How to Maximize Life Insurance Cash Surrender Value?
To maximize the cash surrender value, you should consider...
- Choosing a permanent life insurance policy, such as universal or whole life insurance, as these have a cash value component that can accumulate over time.
- Regularly and timely having premiums paid to help increase the cash value and cash surrender value of your policy.
- Paying more than the minimum premium to help increase the cash value and cash surrender value of your policy faster.
- With a universal life insurance policy, choosing investment options that can offer the best returns and help grow your policy's cash value and cash surrender value.
- Regularly monitoring your policy's performance and adjusting investment options if necessary to ensure best returns.
- Using riders that can add value to your policy and increase the cash surrender value.
- Avoiding taking out loans or making withdrawals from your policy which can reduce your policy's cash value and cash surrender value.
It is important to remember that the cash surrender value of a life insurance policy can vary greatly depending on several factors, including the type of policy, the premium payments, and the investment returns. Work with a financial advisor to ensure that you are making the best decisions for your unique financial situation.
How to Access Cash Value without Surrendering Your Policy
Besides surrendering your life insurance policy, you can access its cash value by any of the following ways:
Taking a policy loan
If your policy has cash value, you can take a loan against it. The insurance carrier will not run a credit check or ask you why you need the loan because you are basically borrowing money that is yours.
You do not even have to pay back the loan — but that does not mean it is a gift. The insurer will deduct the loan amount, plus interest, from the payout it issues to your beneficiary when you pass on. If you have a dependent, consider paying the interest at least. Otherwise, your death benefit might become significantly reduced or completely wiped out.
Before taking an insurance policy loan, keep in mind that the loan amount is not taxable only if the policy is active. If the coverage lapses because of non-payment, you can receive a tax bill. You will only have to pay tax on the part of the loan that exceeds your premium payments (the policy basis).
Making a withdrawal
You can withdraw cash value partially or in full anytime you want. However, a withdrawal can reduce the death benefit significantly or even completely. As such, it might be a good option only if your life insurance needs have reduced.
As is the case with a policy loan, any withdrawal above the policy basis is taxable.
Using the cash value to pay premiums
Once you have amassed enough cash value, you can use it to cover future premiums. If you are currently struggling to pay premiums, this option can make it easier to keep your policy in force. However, keep an eye on your policy’s cash value level, because if you exhaust all of it, your policy could lapse.
Increasing the death benefit
Another way to tap into the cash value without taking a cash surrender value is by using it to increase the death benefit amount. This way you can ensure your hard-earned money does not go into your insurer’s pocket after your death.
Selling your life insurance policy
If your insurance policy has sufficient cash value and you no longer need coverage, you may consider selling it to a third party. In return, you will receive a one-time cash payment, which is likely to be more than the cash value but less than the death benefit. The new policyholder will pay all the future premiums and receive the death benefit upon your death.
As is the case with surrender, you will be taxed for the amount that exceeds the policy basis. Nevertheless, you should end up with more than the cash surrender value. However, the process of selling a life insurance policy — known as life settlement — can be time consuming and finding an interested buyer can be difficult.
The cash surrender value is the amount of money the insurer pays when you decide to terminate universal life or whole life insurance policies. It equals the policy’s cash value minus surrender charges. The surrender charges are expensive during the first few policy years, but they reduce over time. If you are looking to learn more information or have questions about cash surrender values from your insurance policy, feel free to further explore our other content (or articles) regarding life insurance coverage or contact our advisors today to get a guide to your answers and a unique experience.