Surrendering a Life Insurance Policy: What It Really Means

• Surrendering a life insurance policy means voluntarily giving up your coverage. Your protection ends and you and receive the cash surrender value, if available.
• Only permanent policies can be surrendered for cash value. Term life policies don’t have cash value, so cancelling them ends coverage with no payout.
• The amount you receive on surrendering a life insurance policy is usually less than the total premium you have paid. If you receive a higher payment than the premiums you have paid, you may have a taxable event.
• Surrendering a life insurance policy ends the policy's death benefit, leaving no payout for your beneficiaries.

When you surrender a life insurance policy, you voluntarily end your coverage contract with the insurer. In exchange, you get the cash surrender value for your policy if you had a permanent policy. Though you might receive temporary financial relief, there may be deductions in the final amount you receive, plus your coverage will end immediately with no payout for your family.

Why People Surrender Their Policies

There could be many reasons why people surrender their life insurance policies. Some of these are listed below:

• Higher Premiums: Premiums have become unaffordable due to job loss, decreased income, or retirement.
• Major Life Changes: Life goals have changed, and the reason the coverage was needed is fulfilled; for example, a child's education is complete, or debt is paid off.
• Immediate financial need: A sudden medical emergency or other urgent expense has occurred that requires immediate cash at hand.

Though these reasons could seem valid for surrendering your life insurance policy, it is important to weigh the pros and cons of surrendering, especially if you still have people who depend on you financially.

Read: Different types of life insurance

Surrendering vs. Selling Your Life Insurance Policy

Surrendering a life insurance policy does not mean you are selling it. Surrendering means terminating the policy for its surrender value, whereas selling the policy is termed as life settlement, where you sell your policy to a third party. In both cases, your coverage ends.Here is a comparison between the two:

Surrendering or selling your policy can have different outcomes, based on the policy type, premiums paid, and other factors. It is always a good idea to consult a financial advisor before making the final decision.

Read: Why Do I Need Life Insurance

Cash surrender value is the amount you receive when you surrender your policy to the insurer. It is different from the cash value, as there are applicable deductions. Typically it is calculated as follows:

Cash Surrender Value = Cash value minus Surrender charges, minus any outstanding loans and interest.

If you previously withdrew money from your cash value, that amount will have already been deducted.

For example, if your policy has $30,000 in cash value, $5,000 in surrender fees, and $5,000 in outstanding loans including interest, your surrender value would be $20,000.

The surrender charges vary based on the type of policy, loans and withdrawals, and market performance. It also varies as your policy ages; the earlier you surrender, the higher the surrender fee. Cash surrender charges usually decrease as your policy ages, with many insurers reducing or eliminating them after about 10 to 15 years.

Read: Permanent Life Insurance vs Term

Surrendering a life insurance policy is generally not advisable, unless absolutely necessary. When you surrender your life insurance policy, you leave your family without financial protection. And, if you have a permanent policy you miss out on future cash accumulation potential.

Coverage Gaps and Lost Death Benefit

When you surrender a life insurance policy, your coverage ends. Thus, your family doesn’t receive a death benefit payout when you die. It’s also important to remember that obtaining coverage as you age could be expensive, as premiums rise with age due to the risk of health complications.

Missed Tax-Deferred Growth or Payouts

Your permanent life insurance policy accumulates cash value over time that grows tax-deferred. If you decide to surrender your policy and the cash surrender value is higher than the premium you have paid, you may have to pay taxes on the excess amount. You should always speak with a tax professional to see how surrendering your policy might impact you.

Read: Which Policy Component Decreases In Decreasing Term Insurance

Before surrendering a life insurance policy, you should assess your needs and calculate the benefits you might miss upon doing so.

Consider the following:

if you still need life insurance protection

• if the surrender value is worth losing the death benefit
• if there are any cheaper policy options available
• if you can pause or reduce payments instead of canceling

Here are some things to consider:

If, after calculating all pros and cons, you have decided to surrender your policy, here are some steps to follow:

1. Read the Fine Print: Thoroughly review the policy documents and understand the surrender clause, fees, and your current cash value.
2. Request for a Surrender: To begin the process, contact your insurer, and request a policy surrender form along with a written request of the payout.
3. Gather the details: The insurer might need information like your policy number, ID, and other details. Keep important documents handy.
4. Wait for the response: Insurance companies usually process the surrender requests within 2–4 weeks.

After the confirmation, companies make the payout via a check or a direct deposit after making the required deductions as outlined in the policy.

Read: Affordable Life Insurance For Seniors Over 60

When you surrender a life insurance policy, insurers determine the total premium you have paid over the years and the cash surrender value. Based on this:

• If the cash surrender value is less than the total premium amount you have paid, you generally will not be taxed.
• If the cash surrender value is more than the total premium amount you have paid, the excess is typically taxed as ordinary income.

The tax calculation on surrendering a life insurance policy can also be impacted by loans and withdrawals. Plus, cancelling a policy early means you no longer have the ability to grow money tax-deferred. It’s always a good idea to consult a financial advisor before surrendering a life insurance policy.