Did you know that you can actually access the total amount of cash you have already paid in premiums in your life insurance policy?
This amount is what is referred to in the insurance industry as the cash surrender value of life insurance, also known as cash value, policyholder’s equity, and surrender value.
Thus, the cash surrender value can be considered as a savings component of your life insurance policy.
The beauty of this fund is that it is not accumulating tax charges, at least not until the amount is accessed.
The Bottom Line is Here
- You can borrow from your policy.
- Use to pay urgent need of huge cash.
- Lower Interest Rates than Any Bank.
- Good for Long-term investment & Retirement.
However, cash surrender value only applies to permanent life insurance products. These include universal life and whole life policies. In other words, it applies to insurance products that offer premium savings and death benefits.
In comparison, term life insurance does not come with a cash surrender value. That product does not offer any similar payout prior to the date of policy maturity.
This is another logical reason why term life insurance policies usually command premiums that are lower than permanent life insurance policies.
Understanding How Cash Surrender Value Works?
As you may have been noticing, the cash surrender value of your life insurance policy grew slowly during its first few years.
That is because in general, commissions of agents and some other startup costs were incurred and covered during the period.
However, after several years of being in force, the growth pace steadily picks up.
If you surrender your insurance policy in exchange for cash, your insurer could terminate it. But there are other possible options to be taken to prevent termination from happening, although you still get to use your policy’s surrender value.
First, you can opt to access just a portion of that cash surrender value to keep the insurance policy in force and active. This is important if you like to remain insured no matter what happens.
Second, you could strategically take a loan from the insurer and use the accumulated cash value of the policy as your collateral or security.
Taking a Loan Against the Policy
Taking a loan and using the policy’s cash surrender value as collateral is the best and most strategic way to tap that amount of money.
As a policyholder, you can easily qualify for that loan regardless of your income or even credit history. This makes it an option that is recommended for borrowers who are often declined by lenders because of their bad credit ratings.
You can also opt whether to repay the loan or not. However, be reminded that it is a prerogative that would bring about consequences if you choose not to repay the loan.
Although that decision would not automatically terminate the insurance policy and its coverage, you must be aware that the unpaid loan balance (plus interest) would then be deducted from the payout your beneficiaries could claim upon your death.
This loan advantage of your policy is also better compared to most other types of loans available in the market. That is because such loans usually come with lower interest rates. Another advantage would be its tax ramifications.
Taxation of Cash Surrender Value Loans
If you tap cash surrender value of your life insurance as a loan, you would enjoy a tax-free transaction. This remains as long as that withdrawal does not exceed the overall amount you have so far paid in premiums over the duration of the life insurance policy.
However, even if your loan amount does exceed the total amount of premiums paid, you would only be taxed just on the amount that has exceeded your paid premiums.
For instance, if you have already paid $10,000 in premiums for your policy, you would not incur any tax cost if you have withdrawn an amount that is less than $10,000. If you have withdrawn $11,000, you would be taxed only for the excess, which is $1,000.
However, there is another tricky instance. If your loan exceeded the total premiums you have paid, never let the policy expire before you make the full repayment.
That is because if it does lapses after the cashout, the entire withdrawn amount becomes taxable.
Other Ways to Monetize Your Policy
Of course, loans may not be the only way you can access your accumulated cash surrender value. Another way to get cash from the policy is simply waiting for its dividend payouts.
Insurance dividends refer to the amount left over from your premiums after all overhead costs and claims get paid.
Such amounts are also not taxable as the IRS usually considers those as the return of premium instead of a traditional dividend. But the amount may not be significant enough to cover your financial requirements.
Another way is through early termination or cancellation of the insurance policy. This is usually an option for policyholders who have already paid premiums for at least three years.
Upon termination, the total amount of premiums contributed could be en-cashed but with corresponding fees that would in effect lower the cash value.
The last option to take is to go for a life settlement. In such a transaction, you will sell the life insurance policy to a third party or buyer.
This is a form of cash sale and you as the seller could get the total amount you have paid as premiums. However, there could also be charges imposed and the buyer may ask for discounts.
The Downside
If you decide to withdraw your life insurance policy’s cash surrender value, you should also be aware of the repercussions and setbacks that the decision may bring about.
The most pressing concern would be the possible removal of the cash value of your insurance policy.
If something unexpected happens, the value withdrawn plus corresponding interest would have to be deducted from the claims your beneficiaries could withdraw. That amount may not matter now, but it may be very significant in the future.
If you decide to terminate the policy to withdraw your cash surrender value, it would cancel your policy, leaving you vulnerable to life’s uncertainties.
It is not advisable to live without any form of life insurance if you intend to keep your family protected in case unexpected and inevitable events happen to you, the breadwinner.