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One of the benefits of a cash value life insurance policy is that you have access to the money while you are still alive. There are several ways you can take out cash value, including surrendering the policy for a lump sum. Here’s how it works and when it makes sense to drop a life insurance policy.
Ways to Access Cash Value in Life Insurance
If you have a permanent life insurance policy, it probably has a cash value component. There are several ways you can access this money as a policyholder.
You have the option of withdrawing funds from the cash value portion of your policy. As long as you only withdraw up to the amount you’ve paid in premiums (known as your cost base) and not the profits you’ve earned, you won’t owe tax. You can withdraw more than your cost basis, but be prepared to pay taxes on that portion.
Cash value withdrawals will reduce the death benefit your beneficiaries receive.
You can also take out a loan against the cash value of your policy. There is no loan application process or credit check 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 is deducted from the death benefit paid to your beneficiaries.
Surrendering a life insurance policy means canceling the policy and receiving its surrender value, which is the cash value minus any surrender charges. If you go this route, coverage ends. Your beneficiaries will not receive a death benefit when you die.
You will owe taxes on the amount you receive that is above your cost base.
If you no longer want or need your policy, you can sell it to a third party in what is known as a life settlement. You get a lump sum cash payment, often for more than the surrender value (more on that later). The buyer assumes responsibility for the policy, including making the premium payments, and receives a death benefit when you die.
Living settlements are usually designed for elderly people who are in poor health.
When to surrender your life insurance
With the different ways to access your cash value in life insurance, you may be wondering when is the best time to surrender your policy for cash. Here’s a look at some scenarios where this might make sense.
You found a better deal
Although life insurance quotes go up with age — and new health issues you develop — there’s a chance you’ll qualify for a more affordable policy today than when you first took out your current one. For example, maybe your health has improved significantly or you’ve stopped smoking.
In this case, it may be worth shopping around for a new one at a lower price. Make sure your new policy is in effect before you cancel your current policy. Also, before you buy new life insurance, look into whether a 1035 exchange could save you money on taxes.
You can’t afford the premiums
Permanent life insurance is significantly more expensive than term life insurance. If premiums take up a large portion of your income, you may be better off with a cheaper term life policy. Consider looking into term life insurance coverage to compare costs.
You no longer need life insurance
There are some cases where you may simply no longer need life insurance coverage. For example, if no one is financially dependent on you anymore, you may not need life insurance. It may not make financial sense to keep your policy in force.
You need a large amount of money quickly
If you have a large expense to cover or perhaps a better investment opportunity, but don’t have any liquid assets to draw on, a cash value life insurance policy return can be a decent option, especially if your actual need for life insurance has diminished .
How to calculate the cash surrender value?
The surrender value of a policy is based on the portion of the premiums that went into the cash value account plus the interest rate paid or investment earnings. Outstanding loans are deducted from this, along with any repossession fee.
Some policies take many years to build up any significant cash value, so you may not have much cash value anyway.
Over time, transmission fees tend to decrease. Ideally, you would wait until the fee is minimal or non-existent. Plus, the longer you hold the policy, the larger the cash value is likely to be.
Also, remember that if your cash back value is worth more than you paid in premiums, you’ll have to pay income taxes on the difference.
Finally, keep in mind that your beneficiaries will not receive a death benefit if you surrender your policy. So when researching your options for obtaining cash value from life insurance, consider how each method will affect your long-term planning and estate goals. There may be a better option if you need the money.
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Life Insurance Surrender FAQs
Can you cancel a term life insurance policy?
You can cancel a term life insurance policy at any time, but since there is no cash value component included in term life, there is no money back.
What is cash surrender value?
Cash surrender value is the amount you receive if you surrender a life insurance policy with cash value, such as whole life insurance. This is the cash value you have minus any transfer fees. Surrender charges can continue for about 10 to 15 years after the policy is purchased.
Will I pay taxes on the cash surrender value?
If the cashback value you receive is more than what you paid in premiums (cost basis), you may be taxed on the amount above what you paid. Talk to a tax professional to determine when life insurance is taxable.