One advantage of buying permanent life insurance is that it offers both a death benefit and cash value. If you no longer need life insurance — say, because your children are grown and financially independent — you can cash out the policy. The cash surrender value is the money you’ll receive after terminating a permanent life insurance policy.
There are some downsides to cashing out a life insurance policy, however. Withdrawing cash from your life insurance could have tax implications or reduce the death benefit of the policy.
Does your life insurance have cash value?
Not all life insurance policies have cash value. To get cash out of your life insurance, it needs to:
- Be a permanent life insurance policy with a cash value component.
- Have earned enough cash value to withdraw or borrow against, which could take years or even decades.
Permanent life insurance costs much more than term life. But when you pay your premium, part of it is funneled into a cash value account that you may be able to withdraw or borrow against later. Here are a few types of permanent life insurance that can build cash value.
Whole life insurance
The cash value accumulates at a rate guaranteed by your insurer. If your policy earns life insurance dividends, the cash value and cash surrender value can grow at a higher rate than the insurer guarantees.
Universal life insurance
The cash value and cash surrender value increases or decreases based on current interest rates. Cash value can also be affected by the cost of insurance and expense charges.
Variable life insurance
Both variable and variable universal life policies let you invest the cash value in mutual fund-like subaccounts. Your cash value has more growth potential, but could drop if the market performs poorly or the cost of insurance changes.
Indexed universal life insurance
The cash value of indexed universal life insurance policies is tied to an index, like the S&P 500. Your cash value will increase or decrease based on the performance of the indexes. These policies typically have minimum guaranteed returns and a cap on maximum returns.
Term life insurance doesn’t have a cash value, so you can’t withdraw money from it. However, it’s typically the most affordable life insurance and covers the years when you’d need life insurance the most.
» MORE: Term vs. whole life insurance
How the cash surrender value works
Cash surrender value is the amount a policyholder receives when a permanent life insurance policy is cashed in before it matures.
How cash value accumulates
When you buy permanent life insurance, part of the premium goes toward insuring your life. The remainder goes toward a cash value that functions like a savings account. Cash value is the amount of money in your policy. It grows slowly at first, but the value can accelerate over time thanks to the power of compound interest and earnings.
How long does it take to build cash value?
It takes time for permanent life insurance policies to build up cash value. If your policy is relatively new, it’s unlikely to have much cash value yet. As you pay your premiums over time, a portion will be invested into your policy’s cash value, which will grow at either a fixed or variable rate.
The cash value of your policy can be much less than the total premiums you’ve paid or the face amount of life insurance you bought.
What happens when you cash out a life insurance policy?
If you opt to terminate your policy, your loved ones won’t receive a death benefit. Instead, you’ll receive the policy’s cash surrender value. This is the cash value minus any surrender charges or fees, policy loans or prior withdrawals.
Because policies don’t have much cash value in the first few years, you typically won’t get a lot of money when surrendering your policy early on. Plus, most policies charge surrender fees for the first 10 to 15 years that the policy is in force.
Surrender fees start out at their highest in the first year of your policy’s life and go down slightly each year after that.
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How the cash surrender value is calculated
The cash surrender value equals the policy’s cash value minus surrender fees. Any loans you’ve taken against the policy or unreimbursed withdrawals will also decrease the cash surrender value.
Due to surrender fees and the slow cash value growth, the cash surrender value will usually be less than the premiums you’ve paid for the first few years. The longer the policy remains in force, the closer the cash value will be to the cash surrender value.
The cash value in a permanent life insurance policy grows on a tax-deferred basis. But if you cash out a policy, you’ll typically owe taxes if the cash surrender value is higher than what you paid in premiums.
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For example, say you’ve paid $20,000 in premiums and the cash value of your policy is $25,000. Your policy has a 4% surrender charge to terminate it, resulting in a surrender charge of $1,000 and a cash surrender value of $24,000. Generally, the $4,000 gain would be considered taxable income.
Most policies pay the cash surrender value in a lump sum, though some may make periodic payments. Check your policy contract to learn how the carrier pays out cash surrender value.
When to consider surrendering your policy
Surrendering a life insurance policy is a big decision, given that your loved ones won’t receive a death benefit. However, there are some scenarios where terminating a policy for the cash surrender value makes sense:
- You need a large sum of money. When you surrender your policy for its cash value, you can use the money however you want. That can be helpful if you’re facing major medical expenses or home repairs, you need to pay off debt, or you want to save more for retirement or an emergency.
- You no longer need life insurance. Life insurance needs change over time. If your children are grown or you’ve paid off your mortgage, you may opt to surrender a policy for the cash value since your loved ones don’t need a death benefit.
Pros and cons of cashing out your policy
Pros
You can access your policy’s full cash value (minus fees or penalties).
Cons
You’re no longer covered, so your beneficiaries won’t get a death benefit.
Penalties or fees can chip into available cash.
You might owe income taxes on part of the cash you receive.
» MORE: Who needs life insurance?
Alternatives to surrendering your cash value policy
If you need cash from your life insurance policy, terminating the contract isn’t the only option. Consider these alternatives to surrendering a policy.
1. Make a partial withdrawal
You can usually withdraw part of the cash value in a permanent life policy without surrendering it entirely. However, the death benefit your beneficiaries receive might be smaller.
Pros
Your life insurance policy remains in effect.
You’re not required to pay back the money you withdraw.
Not subject to income taxes as long as you withdraw less than you’ve paid in.
Cons
The death benefit paid to your beneficiaries is reduced.
Policies can have limits on when or how much you can withdraw.
Fees or penalties might eat into the amount you receive.
2. Borrow from the policy
Many policies allow you to borrow against the cash value. Borrowing against life insurance might be easier than getting other kinds of loans. But it’s still a loan, so there’s interest to pay and consequences for not paying it back.
Pros
No credit check for approval.
Typically lower interest rates than personal loans or credit cards.
Choose your own schedule for repayment.
Cash value continues to grow even if you’ve borrowed against it.
Cons
It might take years to build up enough cash value to borrow against.
There’s still interest, which could add up over time.
Unpaid loan balances could reduce your death benefit or cause your policy to lapse.
Potential tax implications if you don’t repay your loan or your policy lapses.
If you need money to pay bills, and one of those bills is the life insurance premium itself, your cash value can come in handy. You may be able to use the cash value to skip making out-of-pocket premium payments on your policy.
Pros
Your policy remains in effect.
Lower monthly bills could free up cash for other expenses.
Cons
Covering premiums probably won’t provide a large amount of cash at once.
Cash value used to cover premiums isn’t available if you need it later.
🤓Nerdy Tip
Keep in mind that taking out a policy loan, withdrawal or using the cash value to pay premiums may impact your policy's future performance. It’s important to request a life insurance illustration every two years to monitor your policy’s projected performance.» MORE: Is life insurance taxable?
Frequently Asked Questions
Does term life insurance have a cash surrender value?
No. Term life insurance doesn’t have a cash surrender value because it only offers a death benefit and doesn’t build cash value.
Is the cash surrender value of life insurance taxable?
If the surrender value is more than the premiums and surrender fees you paid, you’ll often owe income taxes on the excess. For example, if you paid $10,000 in premiums and a policy built $12,000 worth of cash value, you’d typically owe taxes on the $2,000 difference.
What’s the difference between cash value and surrender value?
Cash value is the amount of money that accumulates in the savings component of a permanent life insurance policy. Cash surrender value is the amount of money the policyholder gets when they terminate their policy. Cash surrender value is usually the cash value minus surrender fees.
