Want to Surrender a Life Insurance Policy? Here's What Happens

Taking out a life insurance policy provides your family with financial protection following your death. When you take out a policy, you have the option of term life or whole life. Term life covers you for a set number of years, while a whole life policy remains in place for your entire life. 

For one reason or another, you may decide that you want or need to cancel your life insurance policy. Rather than hanging onto it and continuing to pay into it, a common solution is to surrender it. Here’s what you can expect. 

What Does It Mean to Surrender A Life Insurance Policy?

When you surrender your life insurance policy, you essentially cancel it. Surrendering is common for whole life insurance policies, which accrue cash value over time. By surrendering, you agree to take the cash surrender value (which is assigned by your insurance provider) while also forgoing the death benefit. 

Can You Surrender at Any Time?

You can surrender your life insurance policy whenever you need to. Keep in mind, however, that the age of your policy could affect the money you receive. Generally speaking, the longer you’ve had the policy, the more you’re likely to get. Younger policies, on the other hand, might not pay out much (if anything) at all. 

Many insurance companies have what’s known as a “surrender period” in place during the first few years. Surrendering during this time could mean that you get no money. Other insurers may impose steep penalties for canceling early on to recoup the costs associated with selling you the policy and getting it set up. 

If you’ve decided that you no longer want or need your life insurance policy, the first step is to contact your insurance company. You may be able to write a letter of intent, or the company may require you to fill out a surrender form. Send the required information to the company and make sure they receive it. Once your insurer processes the request, you should receive the cash surrender value for your policy. 

What About a Term Life Policy?

Term life insurance is a bit different from whole life. It’s only in place for a set number of years, as opposed to your entire life. You can renew it after the policy period ends, but it’s not always necessary. 

Another significant difference between term and whole life insurance is that term life policies don’t accrue any cash value. If you decide that you want to surrender the policy before the end of your coverage period, you don’t receive any money for doing so. Canceling the policy means that you don’t have to make any more monthly payments. 

Understanding Your Cash Surrender Value

As mentioned above, the longer you’ve had your life insurance policy, the more you’re likely to receive. What you get is known as the cash surrender value. While often confused with the cash value, the surrender value is generally lower. The reason for this is because of the costs associated with canceling your insurance policy.

Your insurer calculates your cash surrender value based on a few different factors:

• The total amount you’ve paid into the policy

• The performance of the investments your money is held in 

• Surrender fees

Essentially, the cash surrender value is what you receive after your insurance company takes out all applicable surrender fees, administrative fees, and any outstanding loans you might have through the policy. Different insurance companies charge different fees to surrender a policy. You should contact your insurer to find out the exact costs for canceling yours. 

In general, the earlier you cancel your life insurance policy, the steeper the fees you pay. Some insurers may decrease the fee annually during the first 10 to 15 years of the policy, which means you’ll pay less the longer you wait. After this period ends, the company may not charge any fees. Again, check with your insurance company to get a better understanding of the fees you might have to pay if you decide to surrender your policy. 

Tax Implications for Surrendering Your Life Insurance Policy

Another thing to keep in mind when surrendering your life insurance policy is that some of the funds are subject to being taxed as income. The money you pay in (the cost basis) won’t be, but anything you receive over what you paid in is taxable. 

Let’s say that you paid $10,000 into your policy while you had it. When you surrender it, the cash value is $15,000. If you pay $1,500 in fees, you receive $13,500. The $10,000 you paid in originally is your tax-free return on investment. You will, however, pay taxes based on your tax bracket on the additional $3,500. 

Reasons You Might Surrender Your Policy

So, why would you want to surrender your life insurance policy anyway? There are several reasons people choose to cancel their current policies, including:

• You no longer need the coverage (your beneficiary passed away, you’re getting divorced, or your children are adults and you no longer need the policy)

• You improved your health, and you now have access to cheaper life insurance options

• You want or need to access the money (you need the funds to cover an emergency expense, or you want to put the money toward a more lucrative investment opportunity)

• The premiums are too expensive

• The policy doesn’t meet your needs anymore

Alternatives to Surrendering

While you can surrender your life insurance policy if you want, you should know that you have other options available. Explore these options before you make a decision.

Take Out a Policy Loan

One of the most common options for accessing the cash value of your life insurance policy without surrendering it is to take out a policy loan. With this solution, you receive funds while using your policy as collateral. While you’re borrowing money from yourself, you do have to pay interest while paying back the loan. In most cases, however, the rate is lower than what you’d get if you took out a personal loan from a bank. There are also no underwriting requirements, so you can still take out a loan even if you don’t have the best credit. Defaulting on your payments, however, could cost you your policy. 

Make a Direct Withdrawal

With a direct withdrawal, you take out some of the cash value, but leave enough behind to keep your policy active. You also continue to make your monthly premium payments so that you keep your death benefit.

While a direct withdrawal is fairly simple, there are a couple of things to keep in mind. First, withdrawing the money could increase your monthly payments. If your new premiums are higher than you can afford, your policy may lapse, and you lose the coverage. Second, your death benefit may decrease by the amount you take out, decreasing the amount your beneficiaries receive upon your death. In some cases, the money you withdraw may also be subject to taxes. 

Take a Life Settlement

A third, and possibly most profitable, alternative to surrendering your life insurance policy is to take a life settlement. Using this option, you sell your policy to a qualified buyer. The buyer assumes the payments and their beneficiaries receive the death benefit. One of the main advantages of this is that you get a lump sum payment at the time of purchase. You’ll likely get more money than if you surrender the policy. You may even be able to get up to three times the policy’s cash value. The thing to remember, however, is that the money you receive is subject to taxes, so it may be worth your while to consult with a tax professional. 

If you no longer want or need whole life insurance, surrendering it provides you with access to the funds that you’ve accumulated during its life. While it can be a good option if you’ve had your policy for many years (or even a few decades), surrendering it early on could lead to significant fees. Make sure you look into how your insurer handles surrendering, as well as what other options you have available before you make your decision.