Understanding Partial Surrender In Life Insurance Policies

A partial surrender of a life insurance policy allows the policyholder to withdraw a portion of the policy's cash value while keeping the policy active. This means the policy owner can remove some of the cash value from their policy without having to cancel the entire policy. Partial surrenders are sometimes used when the policyholder needs financial security during their lifetime, such as to pay off medical bills or repair a leaking roof.

Partial surrender vs withdrawal

A partial surrender of a life insurance policy allows the policy owner to withdraw some of the cash value while keeping the policy in force. This means the policy owner can remove some of the cash value without having to cancel the entire policy.

In the life insurance world, the terms "partial surrender" and "withdrawal" are effectively synonymous. Industry professionals often use the two terms interchangeably, with "withdrawal" being the preferred term as it is less confusing to the general public.

Types of Policies That Allow Partial Surrenders

Universal life insurance policies and whole life insurance permit partial surrenders, but the two policy types approach them differently. Universal life insurance policies allow the owner to withdraw any cash surrender value whenever they want, with little to no effect on the death benefit. Whole life insurance, on the other hand, has specific rules about partial surrenders. Whole life policy owners can only withdraw cash value created through the elective paid-up additions rider or dividends used to purchase paid-up additions. They cannot withdraw cash value accumulated through the guaranteed accumulation of base whole life cash value. However, they can take a partial reduction of the death benefit on their base whole life policies to achieve a partial surrender of the base guaranteed cash value.

When to Withdraw Money from a Life Insurance Policy

You can make a partial surrender of a life insurance policy whenever you have cash surrender value in the policy. This could be as early as the first policy year. Partial surrenders usually have no waiting period, unlike policy loans, which can have a waiting period. However, universal life insurance policies may apply pro-rated surrender charges to partial surrenders if they exceed 10% of the net cash value of the policy.

Partial Surrender vs Loan

Partial surrenders involve the permanent removal of cash value from a life insurance policy. The policy owner generally does not have the option to put the money back into the policy. Life insurance policy loans, on the other hand, allow the owner to put the money back into the policy by paying off the loan. Therefore, if there is a temporary need for money or a plan to put the money back, a loan is the preferred option.

Tax Implications of Partial Surrenders

Partial surrenders release the cost basis first, which is one of the tax benefits of life insurance. As long as the partial surrender amount does not exceed the sum of premiums paid by the policy owner, there is no tax liability on the distribution of monies from the policy. However, once the policy owner recovers all of their cost basis in the policy, any future partial surrender will be considered ordinary income and will be subject to income taxes.

When to use a partial surrender

A partial surrender of a life insurance policy is a significant decision that can help offset sudden financial needs. It allows policyholders to withdraw a portion of the policy's cash value while keeping the policy in force. Here are some scenarios when a partial surrender could be beneficial:

• Financial Hardships: A partial surrender can provide much-needed funds during financial hardships, such as job loss, medical bills, or unexpected expenses like home repairs. It allows policyholders to access cash while retaining their life insurance protection.
• Financing Education: Withdrawing a portion of the policy's cash value can help finance a child's education without incurring debt. This can be especially useful if other sources of funding are unavailable or costly.
• Down Payment on a Home: If you are looking to purchase a home and need a down payment, a partial surrender can provide the necessary funds. This can be a better alternative than taking on additional debt through loans or mortgages.
• Investing in Business Opportunities: A partial surrender can provide capital to invest in business ventures or opportunities. This can be advantageous if you are looking to diversify your income streams or expand your business.
• Premium Payment Difficulties: If you are facing challenges in keeping up with premium payments, a partial surrender can help reduce the financial strain. By withdrawing a portion of the cash value, you can free up cash flow while still maintaining the policy.

It is important to carefully consider the implications of a partial surrender, as it will result in a decrease in both the cash value and death benefit of the policy. Additionally, there may be potential charges, fees, and tax consequences associated with the withdrawal. Consulting a financial advisor or insurance professional is recommended to weigh the benefits and ensure you make an informed decision.

How a partial surrender works

A partial surrender of a life insurance policy allows the policyholder to withdraw some of the cash value while keeping the policy in force. This means the policy owner can remove some of the cash value without cancelling the entire policy.

Universal life insurance policies and whole life insurance permit partial surrenders but they approach it differently. Universal life insurance policies allow the policyholder to withdraw any cash surrender value whenever they want. Whole life insurance, on the other hand, has specific rules about partial surrenders. Whole life policy owners can only withdraw cash value created either through the elective paid-up additions rider or dividends used to purchase paid-up additions. They cannot withdraw cash value accumulated through the guaranteed accumulation of base whole life cash value. However, they can take a partial reduction of the death benefit on their base whole life policies to achieve a partial surrender of base guaranteed cash value.

To initiate a partial surrender, the policyholder must first contact their insurance company or agent to get the details on how the insurance company handles surrenders. The agent/company will ask how much the policyholder wants to surrender and will provide information on how much of the policy will remain. The full amount of surrendering a policy is called the cash surrender value. The policyholder will then submit a request for the partial surrender, specifying the amount they wish to withdraw. The insurance company will then process the paperwork and send the money, either by cheque or direct deposit.

It is important to note that a partial surrender will lower the cash value of the policy. If the insured dies while there is still an unpaid cash value balance, the amount of that unpaid balance will be charged against the death benefit paid out to the policy's beneficiary. There may also be additional costs when taking a partial surrender, such as processing and administrative fees.

Partial surrender vs loan

A partial surrender of a life insurance policy allows the policy owner to withdraw a portion of the policy's cash value while keeping the policy in force. This means the policy owner can remove some of the cash value from their policy without having to cancel the entire policy.

Partial surrenders and loans are two different ways for policy owners to access the cash value of their life insurance policies.

Partial Surrender

• Permanent removal of cash value from the policy.
• The policy owner generally does not have the option to put the money back into the policy in the future.
• There may be partial surrender charges.
• There may be tax consequences depending on the amount withdrawn and the cost basis of the policy.
• The death benefit may be reduced.
• No waiting period.
• Universal life insurance and whole life insurance permit partial surrenders.

Loan

• The policy owner can borrow against the accumulated cash value in the policy.
• The money can be put back into the policy by paying off the loan.
• Loans are tax-free.
• Interest on policy loans is not tax-deductible to individuals.
• There may be a waiting period.

The main difference between a partial surrender and a loan is that a partial surrender involves a permanent removal of cash value from the policy, while a loan allows the policy owner to borrow against the cash value and put the money back into the policy in the future.

Therefore, if the need to take money from the policy is permanent, a partial surrender may be the best option. However, if the need for money is temporary, a loan may be preferable.

Tax consequences

Partial surrenders can have tax consequences depending on the amount withdrawn and the cost basis of the policy. If the amount withdrawn does not exceed the sum of premiums paid by the policy owner, there is no tax liability on the distribution of monies from the policy. However, once the policy owner recovers all of their cost basis in the policy, any future partial surrender will be taxed as ordinary income and the policy owner will owe ordinary income taxes on the distributions.

If the policy owner withdraws less than they have paid into the policy, they will not be taxed on the withdrawal at all. Conversely, if the withdrawal exceeds the policy's basis (premiums paid reduced by any amount withdrawn), the difference (gain) will be subject to income tax, unless the policy is being replaced or exchanged in a qualifying transaction.

It is important to consult a qualified tax professional to understand the specific tax implications of a partial surrender, as there may be ways to structure the withdrawal to minimize tax liability. For example, using policy loans instead of partial surrenders will prevent any tax liability because policy loans are not considered taxable distributions from the policy.

Frequently asked questions