How To Surrender Your Life Insurance Policy?

Surrendering a life insurance policy means cancelling the policy and receiving a lump sum payout of its surrender value, which is the cash value minus any surrender fees. This can be an appealing prospect if you no longer need the coverage, but it's important to consider the implications of this decision. By surrendering your policy, you'll lose your life insurance protection and may have to pay fees, resulting in a lower payout than if you sold the policy. Additionally, your beneficiaries will no longer receive a death benefit. Before making a decision, it's advisable to carefully weigh the pros and cons and consult a financial professional to understand the potential tax consequences and alternative options for accessing your policy's cash value.

Surrender fees

The surrender charge is usually waived if the insured party informs the insurer in advance of the cancellation of their life insurance policy and continues to pay for a period before cancelling the policy. Surrender charges can also be avoided by understanding that life insurance is a long-term investment and that premiums will need to be paid for many years, even in the event of a job loss.

The surrender fee is typically higher if you withdraw funds within the first years of an annuity contract. A typical surrender fee schedule could be:

• 7% if you withdraw funds in the first year
• 6% in the second year
• 5% in the third year
• 4% in the fourth year
• 3% in the fifth year
• 2% in the sixth year
• 1% in the seventh year
• 0% in the eighth year and beyond

The surrender fee is designed to allow the insurer enough time to recover its expenses, largely commissions, in setting up the annuity contract. It also discourages annuity buyers from using deferred annuities as short-term investments for quick cash.

For example, if you surrender a policy with a cash value of $30,000 and surrender fees of $5,000, you will receive a final cash surrender value of $25,000.

Tax implications

Surrendering your life insurance policy means you will receive a lump sum payout, but you will also have to deal with certain tax implications. Here are the key points to consider:

Taxable Amount

The cash surrender value of a life insurance policy is generally taxable. You will need to pay taxes on any amount you receive that exceeds the policy's basis or the total amount of premiums paid. This additional amount is typically taxed as income. Therefore, it is important to understand the tax-free portion, which includes the money paid in premiums over the life of the policy. Consult a tax expert to ensure proper reporting and to understand the specific tax liabilities for your situation.

Timing of Surrender

The timing of your surrender can impact the cash surrender value. Surrendering the policy earlier in the term may result in a lower cash surrender value since the cash value will be smaller, and you may have to pay surrender charges. On the other hand, surrendering the policy later can lead to a larger payout as the cash value will have grown, and you will pay fewer fees. Most policies have a waiting period, typically of at least 15 years, before you can surrender them.

Surrender Fees

Surrender fees are an important consideration when thinking about the tax implications of surrendering your life insurance policy. These fees are usually higher in the early years of the policy and then gradually decrease over time. Surrender fees can significantly reduce the amount of cash you receive, as they are deducted from the cash surrender value. By waiting until these fees decrease or disappear, you can maximise the amount of money you receive.

Outstanding Policy Loans

If you have any outstanding policy loans that exceed the policy's cost basis, the insurance company will deduct the loan amount and interest from the cash surrender value. In this case, you will owe income tax on the lower surrender value if it is more than the amount paid in premiums.

Gain or Loss on Surrender

The tax rules regarding gains or losses from surrendering a life insurance policy should also be considered. Any gain from the surrender, where the cash surrender value plus any outstanding policy loans exceed the investment in the policy, will be taxed at ordinary income tax rates. On the other hand, losses from surrendering a life insurance policy are generally not deductible by the policy owner, except in certain limited cases, such as when the loss was incurred in a trade or business.

In summary, surrendering your life insurance policy can have significant tax implications. Be sure to carefully review your policy documents, consult with tax and financial advisors, and consider the timing of your surrender to make an informed decision and understand the potential tax consequences.

Pros and cons

Surrendering your life insurance policy means cancelling your coverage in exchange for a lump sum. Here are some pros and cons to help you decide if this is the right option for you.

Pros

• Easy and fast: Surrendering your policy is a simple and quick process. You just need to contact your insurance company and let them know that you would like to surrender. They will handle the rest of the process and determine the cash surrender value you will receive.
• Get some money back: Surrendering your policy means you will get some money back, which is better than getting nothing if you were to lapse your policy by choosing not to pay.

Cons

• Minimal return: When you surrender your policy, the insurance company will give you a single offer, and their goal is to give you as little money as possible.
• Surrender fees: Insurance carriers often charge fees for surrendering a policy, which can be up to 35% of the proceeds. These fees are usually higher in the early years of the policy and then gradually decrease over time.
• Limited options: The insurance company will give you a take-it-or-leave-it offer, with no room for negotiation. You may find more flexibility and better value by selling your policy on the open market.
• Loss of coverage: Surrendering your policy means you will no longer have life insurance coverage, unless you replace it with a new policy.

Alternatives to surrendering

Surrendering your life insurance policy is a big decision that has financial implications for you and your family. Before you decide to surrender your policy, it's important to explore alternative options that could better suit your needs. Here are some alternatives to consider:

• Partial Surrender: Depending on the contractual terms of your policy, you may be able to withdraw a portion of the cash value while maintaining some death benefit coverage. This option allows you to access funds without completely surrendering your policy.
• Reduce Policy Coverage: If you're struggling with premium payments, consider evaluating the possibility of reducing the policy's death benefit coverage. Lowering the death benefit may result in more affordable premiums, allowing you to keep the policy active.
• Policy Exchange: In certain situations, you may be able to exchange your current policy for another that better aligns with your needs. A 1035 exchange, for example, allows you to transfer funds from one policy to another without incurring taxes.
• Premium Financing: If you have a high-value life insurance policy, premium financing might be an option. This involves borrowing money to cover premium payments, which can be beneficial for estate planning purposes. However, it's important to carefully evaluate the cost of the loan, including scenarios such as increasing loan interest rates or non-renewal of the loan.
• Convert to a Paid-Up Policy: Depending on the type of permanent life insurance policy you own, you may have the option to convert it into a paid-up policy. This means you stop making premium payments, and the policy remains in force but with a reduced death benefit.
• Sell Your Policy (Life Settlement): For policyholders with lower life expectancies or changing insurance needs, a life settlement could be a viable alternative. This involves selling the policy to a third party for a lump sum cash payment, with the buyer becoming the new policyholder responsible for future premium payments.
• Accelerated Death Benefit: If you have a terminal illness or meet certain qualifying criteria, some policies offer an accelerated death benefit rider. This allows you to access a portion of the death benefit early.
• Gift the Policy to a Nonprofit Organization: If you no longer need the policy and want to support a charitable cause, consider gifting it to a nonprofit organization. This can be a way to make a substantial donation while also receiving potential tax benefits.

Remember, it's important to carefully evaluate these alternatives and consult with a qualified life insurance professional to understand how each option aligns with your financial goals and needs.

When to surrender

There are several scenarios in which it may make sense to surrender your life insurance policy. Here are some of the most common reasons:

• You've found a better deal: You may be able to qualify for a more affordable policy now compared to when you first took out your current one. For example, your health may have improved significantly, or you may have quit smoking. In this case, it's worth shopping around for a new policy before surrendering your current one.
• You can't afford the premiums: Permanent life insurance is often much more expensive than term life insurance. If the premiums are becoming unaffordable, you may want to switch to a cheaper term life policy.
• You no longer need life insurance: If no one depends on you financially, you may not need life insurance anymore. In this case, it may not make financial sense to keep your policy.
• You need a large amount of cash quickly: If you have a major expense or investment opportunity and don't have any liquid assets to tap into, surrendering a cash value life insurance policy may be a good option, especially if your need for life insurance has diminished.
• You have unforeseen expenses: If you're facing unexpected costs, such as medical expenses, long-term care, or sudden home repairs, surrendering your life insurance policy can provide you with a lump sum of cash to cover these expenses.
• You have less expensive coverage options: By comparing insurance products and shopping around, you may find a life insurance policy that offers better coverage or a cheaper premium. In this case, surrendering your current policy and switching to a new one may be beneficial.
• Your dependents are now financially independent: Life insurance is often used to provide for loved ones after your passing. However, if your children have grown up and become financially independent, the need for coverage may decrease, making it a valid reason to surrender your policy.

It's important to carefully consider the pros and cons of surrendering your life insurance policy, as it is a significant decision that will impact you and your family. Additionally, review your policy documents to understand any surrender fees, taxes, or penalties for early cancellation.

Frequently asked questions