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One of the benefits of cash value life insurance is that you can access the money while you are still alive. There are several ways you can withdraw money from the cash value, including surrendering your policy for a lump sum. Here’s how it works and when it makes sense to give up life insurance.
Ways to get cash value in life insurance
If you have permanent life insurance, it probably has a cash value component. There are several ways you can access this money as a policyholder.
You have the option to withdraw funds from part of the cash value of your policy. As long as you only withdraw the amount you paid in premiums (known as the cost basis) and not the profits you earned, you won’t owe tax. You can withdraw more than the base price, but be prepared to pay taxes on that part.
Withdrawing from the cash value will reduce the death benefit your beneficiaries receive.
You can also borrow against the cash value of your policy. There is no loan application process or credit check involved as you are essentially borrowing from yourself. You have to pay interest, but the rates are usually low.
If you die before the loan is paid off, the outstanding balance will be deducted from the death benefit paid to your beneficiary.
To give up
Surrendering a life insurance policy means canceling the policy and getting its surrender value, which is the cash value minus any surrender charges. If you go this route, the coverage ends. When you die, your beneficiaries will not receive a death benefit.
You will have to pay taxes on the amount you receive that exceeds the cost basis.
If you no longer want or need your policy, you can sell it to a third party in a so-called lifetime settlement. You get a one-time cash payment, often more than the surrender value (more on that later). The buyer assumes responsibility for the insurance policy, including paying the premiums, and receives a death benefit upon your death.
Life settlements are generally intended for elderly people who are in poor health.
When to Surrender Life Insurance
With the different ways to access your cash value in life insurance, you might be wondering when it’s best to give up your policy for cash. Here’s a look at some scenarios where it might make sense.
You found a better deal
Although life insurance prices go up as you age—and as you develop new health conditions—there’s a chance you can qualify for more affordable insurance today than when you first took out your current one. For example, maybe your health has improved significantly or you’ve stopped smoking.
In that case, it might be worth buying a new one at a lower price. Make sure your new policy is in effect before surrendering your current policy. Also, before buying new life insurance, see if a 1035 exchange could save you money on taxes.
You can’t afford premiums
Permanent life insurance is significantly more expensive than term life insurance. If your premiums are taking a significant bite out of your income, a cheaper life insurance policy may be more beneficial for you. Consider shopping for term life insurance to compare costs.
You no longer need life insurance
There are times when you simply don’t need life insurance anymore. For example, if no one is financially dependent on you anymore, you may not need life insurance. It doesn’t have to make financial sense for your policies to stay in place.
You need a large amount of money quickly
If you have large expenses to cover or perhaps a better investment opportunity, but no liquid assets to draw on, giving up cash value life insurance can be a decent choice, especially if your actual need for life insurance has diminished.
How is the cashback value calculated?
The surrender value of the policy is based on the portion of the premium that went into the cash value account plus the interest rate paid or investment gains. Outstanding loans are deducted from this along with the withdrawal fee.
Some policies take many years to build up substantial cash value, so you don’t have to have a lot of cash value anyway.
Withdrawal fees tend to decrease over time. Ideally, you would wait until the fee is minimal or non-existent. Additionally, the longer you have the policy, the higher the cash value portion is likely to be.
Also, keep in mind that if your cash surrender value is more than what you paid in premiums, you’ll have to pay income tax on the difference.
Finally, keep in mind that your beneficiaries will not receive a death benefit if you surrender your policy. So as you explore your options for getting cash value from life insurance, consider how each method will affect your long-term estate planning and goals. If you need cash, there may be a better option.
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Frequently asked questions about surrendering life insurance
Can you surrender a life insurance policy?
You can cancel a life insurance policy at any time, but since there is no cash value component included in life insurance, there is no money back.
What is cash surrender value?
Cash surrender value is the amount you receive if you surrender a cash value life insurance policy, such as whole life insurance. It is the cash value you have minus any withdrawal fee. Surrender charges can last around 10 to 15 years after the policy is purchased.
Will I pay taxes on the cash surrender value?
If the cash surrender value you receive is more than the amount you paid through premiums (cost basis), you may be taxed on the amount that exceeds the amount you paid. Talk to a tax professional to find out when life insurance is taxable.