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Feb 28, 2022reading time icon7 min

Cash surrender value of life insurance: what you need to know

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Cash surrender value of life insurance: what you need to know
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For many people, life insurance is one of the most important protections to ensure the financial security of their loved ones in the event of death. However, depending on the contract chosen, there are a variety of options available and they are not always easy to understand.

Among those that can potentially be included in your contract is the cash surrender value. But what exactly does this consist of? In what contexts can it be used? In this article, we will analyze all of these aspects, and more.

What is cash surrender value?

In simple terms, cash surrender value is the amount of money you receive when you end your life insurance contract and is based on the amount of money you have invested. However, some contracts permit the insured, after a certain period of time, to withdraw part of this amount without terminating the contract.

Since the cash surrender value may in some cases amount to several thousand dollars, it may be worthwhile to take advantage of it. Note that the amount that can be collected before the end of the insurance policy is usually specified in the contract.

The cash surrender value that you accumulate over the years may be fixed in advance by your insurer. It may vary depending on the number of years the insurance is valid and the premium you pay. It is often zero across the first few years.

Cash surrender value is an option typically associated with permanent life insurance.

Calculating the cash surrender value

Is the surrender value guaranteed?

Depending on the life insurance you purchase, the cash surrender value may or may not be guaranteed by your insurer. You will therefore need to check your contract carefully to find out what applies to your situation. In some cases, only a portion of the surrender value may be guaranteed.

How does cash value life insurance work?

The surrender value and its application are established when the contract is taken out. This allows the insurer and the insured to agree on the amount and the associated conditions, even before the policy becomes effective.

In most cases, the surrender value is calculated according to the capital invested in the insurance. It will therefore vary from one situation to another, depending on the specificities of each.

Once the contract has been taken out and the conditions allowing its use have been fulfilled, the insured will have two options:

  • terminate their insurance contract to collect the full cash surrender value;
  • take a partial surrender of the amount to maintain their insurance (borrow against the cash value).

Full withdrawal of the cash surrender value

Making a full withdrawal of the cash surrender value of your life insurance also means terminating your contract. All sums accumulated over the years will be withdrawn and your insurance policy will be canceled.

If you are contemplating this option, consider this first:

  • You will no longer be insured in the event of death, unless you take out a new insurance policy.
  • Money received from the cash surrender value will be taxable (with some exceptions).

Withdrawal of the cash value

Partial surrender of life insurance

A partial surrender of your life insurance allows you to use part of the cash surrender value and not the whole sum. This involves borrowing a certain amount from your own insurance policy.

Depending on your contract, your insurer could allow you to borrow up to 90% of the accumulated amount. The money withdrawn will however be subject to interest, set by the insurer, and this will generally have to be paid upon receipt of your annual statement.

Keep in mind that the larger the amount withdrawn and the longer the term of your loan, the higher the interest charges will be. The annual cost of your life insurance will therefore be higher.

Is the cash value of life insurance taxable?

In most cases, withdrawal of the cash value will be partially taxable. There are, however, some exceptions, when the withdrawal is made in the context of:

  • a dismissal;
  • early retirement;
  • a disability;
  • a stoppage of self-employed activity following a judicial liquidation order.

Only in these few situations may the cash surrender value be exempt from tax.

Note, however, that loans from your insurer are not taxable.

Is the cash surrender value paid to the beneficiaries in the event of death?

If you do not use the cash value while you are alive, it will not be added to your insurance policy upon your death. Instead, the insurance amount will be paid to your beneficiaries.

In the specific case of universal life insurance, the value of the accumulation fund or a portion of the sums it contains may also be paid.

Using the cash surrender value: your options

How can you use the cash surrender value of your insurance without terminating it?

As mentioned earlier, it is possible to benefit from the cash surrender value of your life insurance without terminating it permanently. Here are some options you might consider.

Ask for an advance on the insurance policy

This option consists of borrowing part of the cash surrender value, using your insurance as collateral. This is a loan, which means that you will have to pay back the amount and the interest on it.

You can either borrow directly from your insurer or from another financial institution.

In the event that you die before your repayment is complete, your insurer (or other lender) will deduct the money owed and the interest from the insurance amount to be paid to your beneficiaries.

Using cash surrender value to pay premiums

Another option you may want to consider is to surrender the cash value to your insurer in exchange for permanent life insurance of a lesser value. You will not withdraw any funds and the amount of your insurance will be reduced, but you will be able to enjoy a few advantages including:

  • coverage until your death;
  • not being required to pay any future premiums.

This option is sometimes called "reduced paid-up insurance".

Switching to term life insurance

It is also possible to surrender the cash value to your insurer in exchange for term life insurance. As in the previous case, you will no longer pay premiums and will remain insured for a few more years (according to the agreement concluded with your insurer).

Note, however, that if your term insurance contract ends before your death, you will no longer be insured. This is an important element to consider before making your decision.

Whatever your intention for using your insurance cash value, be sure to compare the various options available to you and understand all the implications of your choice.

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