Does your life insurance have a cash surrender value?

Permanent life insurance may include a capital accumulation component known as the “cash surrender value.” If you hold this type of policy for a certain number of years, this cash value may come in handy in a number of ways. 

Here are your options at a glance.

Surrender the policy

The first option consists of asking your insurer to terminate your policy by paying you the accumulated cash surrender value. This approach might be contemplated by retirees with significant wealth, for example, who no longer feel that they require the security of a death benefit and would like to use the cash surrender value for other plans or investments. But this decision has two important outcomes. The first, as illustrated in the diagram below, is that a significant portion of the cash surrender value would be added to your current-year taxable income (only the portion corresponding to paid-up premiums from past years would be tax exempt). And the second, obviously, is that your insurance policy would be cancelled.

Partial surrender 

Some policies allow for a partial surrender, where the policy would remain in force and the cash surrender value would continue to grow, but the death benefit would be reduced. As with a full surrender, a portion of the cash payment would be taxable. 

Borrow against the cash surrender value

One way of obtaining your cash surrender value without paying tax on it and without cancelling your insurance would be to take out a “policy loan” from the insurer. In that case, the cash surrender value would serve as collateral. This loan would bear interest, but the interest, along with the loan itself, would only become payable upon your death. For instance, let’s say that you have a policy with a $250,000 death benefit and a cash surrender value of $75,000. To finance an important project, you borrow $40,000 at an interest rate of 5% (i.e., $2,000 per year). After 10 years, your loan will total $60,000 (i.e., $40,000 plus 10 years of interest). If you were to die at that point, the insurer would pay your beneficiaries a death benefit of $190,000 instead of $250,000, with the difference being used to repay the loan. Note that this option, while attractive, can cost a substantial amount in interest.

Suspend your premium payments

With some types of policies, the accumulated cash surrender value can be used to pay your future premiums. So if a time came when you needed to free up some cash, you could stop your premium payments for as long as your cash surrender value was sufficient to cover them, and still keep your life insurance in force. Some fees might apply.

Increase your death benefit

Some types of permanent insurance allow you to use your cash surrender value to increase the death benefit provided by the policy. This option could be practical if your need for coverage has increased: if your family has grown, for example, or if your business has expanded substantially.

Eliminate premium payments altogether

Alternatively, you could ask your insurer to use the cash surrender value from your existing policy to purchase a replacement policy that would have a lower death benefit, but that wouldn’t cost you anything more and would remain in force until your death. This is known as reduced paid-up insurance.

Purchase extended term insurance 

Lastly, you could stop paying your premiums and remain fully insured, but only for a specified amount of time. In this case, your cash surrender value would be used to purchase term insurance for a certain number of years. Suppose that you have a $100,000 whole life insurance policy with annual premiums of $500. You could waive the cash surrender value in exchange for a 10-year term insurance policy with no further premium payments. Thus, you would still have the same $100,000 death benefit, but only for ten more years. If you lived longer than that, the policy would terminate and you would no longer be insured.

Accumulating a cash surrender value is one of the main attractions of permanent life insurance. But as you can see, there’s more than one way to take advantage of this benefit. The best option for you will depend on your personal and professional situation. 

Talk it over with your advisor to gain some insight.