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Tax Consequences of Surrendering Your Life Insurance Policy

Life insurance can be a helpful investment, but some may feel like they no longer need it and want to get some of the money they paid into the policy back. Fortunately, permanent life insurance policies pay out a cash surrender value, allowing you to recoup some of your payments if you no longer need coverage. However, it’s helpful to know that getting the cash surrender value may cause you to owe taxes in certain situations. This article will explain how the cash surrender value of life insurance works and cover the tax implications of surrendering your life insurance policy with cash value.

How the cash surrender value of life insurance works

The cash surrender value of a life insurance plan is the amount you’ll receive if you surrender your policy to your insurer. This amount is based on your cash value, the component of a permanent life insurance policy that can help you build cash value through regular premium payments.

A policy’s cash surrender value depends on the policy’s duration, growth, and assets. Surrendering your policy earlier in the term may result in a lower cash surrender value since the cash value will be smaller, and you may owe surrender charges.1 However, if you surrender the policy later, you could receive a larger payout since the cash value will be larger, and you’ll pay fewer fees.

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Is the cash surrender value of life insurance taxable?

A life insurance policy’s cash surrender value can be taxable. Any amount you receive over the policy’s basis, or the amount you paid in premiums, can be taxed as income.2 Several other scenarios may result in potential tax consequences when you surrender your policy, which we’ll discuss below.

When the cash surrender value of life insurance may be taxable

Surrendering your policy may trigger tax consequences if any of the following occur:

  • You receive more funds than the policy’s cost basis.3
  • You have outstanding policy loans that exceed the policy’s cost basis.1
  • Your cost basis changed while you had the policy, such as reducing the death benefit or adding riders.

How to receive the cash surrender value of your life insurance policy

If you’d like to surrender your policy and receive the cash surrender value, here’s how to do so:

  • 1. Review your life insurance policy’s documents: Gather your policy documents, such as the contract, riders, amendments, and premium payment receipts. Look for wording about cash surrender value, surrender charges, and other surrender-related terms in your documents.
  • 2. Speak with your insurer: Inform your life insurance provider’s customer service that you’d like to surrender your life insurance policy. They will guide you through the insurer’s process for surrendering the policy and paying the cash surrender value.
  • 3. Fill out paperwork: Your insurer may give you a policy termination form, surrender request form, or similar paperwork. Complete these forms, providing all information and documentation it asks for.
  • 4. Receive the cash surrender value: Your insurer will process your surrender request and determine the proper cash surrender value based on the policy’s terms. It will then pay you that amount via check or direct deposit.
  • 5. Consult with a tax expert and financial advisor: Receiving a large payout could trigger tax consequences, so consult with a tax expert to report everything properly. Furthermore, you may consider saving or investing your funds elsewhere. A financial advisor can help you pick the best place for these funds.

Should I surrender my life insurance policy?

Here are some factors to consider before surrendering your life insurance policy:

  • Your coverage needs
  • The cash surrender value
  • The cost of getting another life insurance policy
  • Future financial goals
  • Surrender charges
  • Tax consequences

Alternatives to getting the cash surrender value of your life insurance policy

You don’t have to surrender your life insurance policy to access your cash value. Some additional ways to use your cash value while maintaining your coverage include:4

Borrow from your cash value

You can borrow against your permanent life plan’s cash value at low interest rates and favorable terms. Policy loans have no due date. However, keep in mind that interest accumulates on your outstanding loan balance. Your policy can lapse if the loan balance grows larger than your remaining cash value.

Withdraw from your cash value

Withdrawing from your cash value lets you tap into your wealth without a loan and without surrendering your policy. However, withdrawals may trigger tax consequences if you withdraw investment gains. Furthermore, withdrawals may reduce your death benefit.

Use your cash value to pay premiums

Many permanent life insurance policies let you pay premiums with cash value once you accumulate enough. This can help you cut your life insurance costs while maintaining full coverage. However, if you drain your cash value, your policy can lapse.

Learn more about life insurance

Surrendering your life insurance policy lets you receive a significant payout, but you must give up your coverage and potentially owe taxes. Plus, surrender charges could eat into your funds if you surrender too early.

Instead, you might choose to borrow against or withdraw from your cash value, or even use it to pay premiums if your policy allows it. That way, you can keep your coverage and tap into your hard-earned cash value. If you’re ready to help protect your loved ones or start planning for your future, speak with an Aflac agent about your life insurance options.

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