What Do You Call Cashing In a Life Insurance Policy

What It Means to Cash In a Life Insurance Policy

Cashing in a life insurance policy is called a surrender. When you surrender a policy, you stop paying premiums and request the insurance company to return the accumulated cash value to you. The amount you receive is known as the cash surrender value, and it is typically less than the policy's death benefit because the insurer deducts surrender charges and any outstanding loans.

How the Cash Surrender Value Works

Whole life and universal life policies build cash value over time as a portion of each premium payment is set aside and invested by the insurer. The longer you hold the policy, the larger this cash reserve grows. When you surrender, you receive the cash surrender value minus any outstanding policy loans, unpaid interest on those loans, and surrender charges imposed by the contract.

Surrender charges usually decline over the first five to fifteen years of the policy and eventually reach zero. If you surrender early, the deduction can be substantial, sometimes leaving you with only a fraction of the total premiums paid.

Key Terms to Understand

• Cash Surrender Value: The amount the insurer pays you when you voluntarily terminate the policy.
• Surrender Charge: A fee the insurer deducts to cover administrative costs and commissions during the early years of the policy.
• Policy Loan: A loan you took against the cash value, which must be repaid or will be deducted from the surrender proceeds.
• Death Benefit: The amount paid to beneficiaries upon the insured's death, which is separate from the cash value.

Tax Implications of Surrendering a Policy

When you surrender a life insurance policy, any gains above your cost basis are generally treated as ordinary income by the IRS. The cost basis equals the total premiums you paid minus any dividends you received. If the policy was held inside a tax-advantaged account or structured in certain ways, the tax treatment may differ. Consulting a tax professional before surrendering is advisable, especially for policies with significant cash value growth.

Alternatives to Full Surrender

A full surrender is not the only option. Consider these alternatives before cashing in a policy:

• Partial Surrender: Withdraw only a portion of the cash value while keeping the policy active.
• Policy Loan: Borrow against the cash value without canceling the policy, though unpaid loans reduce the death benefit.
• Premium Holiday: Use the cash value to pay premiums for a set period, pausing out-of-pocket payments.
• Viatical Settlement or Life Settlement: Sell the policy to a third party for a lump sum if the insured has a chronic or terminal illness, or is older and no longer needs the coverage.

When Surrendering Makes Sense

Surrendering a policy may be appropriate when the coverage is no longer needed, premiums strain your budget, or the cash value can be put to higher-yielding use elsewhere. It is generally less advisable when the policy is still early in its term, when surrender charges are high, or when the tax hit would erase much of the gain.

If you are unsure, a fee-only financial planner can help you compare the surrender value against your alternatives and model the long-term impact of keeping versus terminating the policy.