Life insurance is one means of ensuring loved ones do not suffer undo financial hardships and are able to continue living with some degree of normalcy, at least in a financial sense, when you pass away. On-time payment of monthly or yearly premiums ensures the policy remains in effect until it reaches maturity, or "paid in full" status. A feature of whole life policies that some are not familiar with is the surrender value, or cash value, of a life insurance policy. This feature can affect the policy both before and after reaching maturity.
Identification
Surrender value can be the amount of money a life insurance policy is worth if you decide to either cancel the policy or take out a loan using the policy as collateral. Whether a life insurance policy has surrender, or cash value, depends on the policy type. Life insurance can be term insurance, or permanent insurance such as universal, variable, variable universal or whole life insurance. Of these, only term insurance does not have surrender value. Permanent insurance accrue cash value over time.
Features
Four features are common to surrender value, no matter which type of permanent insurance you choose. You can consider surrender value as a personal asset. Although withdrawals reduce the death benefit available to beneficiaries, you can withdraw funds or use them as collateral for obtaining a loan. If you choose to look at the life insurance policy as an investment tool, surrender value grows as a tax-deferred asset. If your financial situation makes it difficult to keep up with premium payments, you can use a portion of surrender value to pay premiums until you are in better financial condition. If you decide to withdraw cash, you can request amounts in one lump sum or a tax-exempt annuity.
Timeframe
It takes time for the surrender value of a life insurance policy to accrue. Your age at the time of purchase, along with administrative costs the insurance company intends to recoup are the determining factors in how soon surrender value begins to accumulate. Administrative costs generally include the cost of underwriting the policy and agent sales commissions. Policy documentation will include a schedule, much like an amortization schedule in reverse, which displays surrender value on a monthly or yearly basis.
Misconceptions
A common misconception is to confuse the surrender value of a life insurance with its death benefit value. These are not the same. Death benefit value is the amount of insurance you purchase, adjusted for time and the amount beneficiaries will receive when you pass away, assuming you make no cash withdrawals. For example, if you purchase a $100,000 whole life policy, by year 20, it could have a death benefit value of $115,000 and a surrender value of only $34,000. Surrender value is usually a considerably smaller amount, as it is the value of premium payments in excess of the cost of the insurance.
Considerations
Permanent life insurance is more expensive than its term counterpart is, and surrender value is one of the reasons. In addition, it is important to consider that canceling a life insurance policy with surrender value can have negative tax implications. Internal Revenue Regulation 1.72-11 (d)(11) requires insurance companies to furnish you a 1099-R form that you must include on your annual tax return.
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