If you read the contract of an annuity or permanent life insurance policy, you will come across insurance industry terms that may sound similar but have very different meanings. The list includes terms such as face value, cash value, cash surrender value, surrender cost, and account value. The differences between these concepts are sometimes small, but if you need to withdraw funds from the policy, they can make a big difference.
The cash value and surrender value are different from the face value of the policy, namely death compensation. However, outstanding loans for the cash value of the policy will reduce the total death benefit.
- The cash value or account value is equal to the total amount of funds in the annuity or permanent life insurance policy that generates the cash value.
- In most cases, the difference between the cash value of your policy and the surrender value is the cost associated with early termination.
- After a period of time, the surrender fee will no longer be valid, and your cash value and surrender value will be the same.
The cash value or account value is equal to the total amount of funds in the annuity or permanent life insurance policy that generates the cash value. This is the funds in your account. Your insurance or annuity provider allocates part of the funds you pay through premiums to investments (such as a bond portfolio), and then credits your insurance policy based on the performance of these investments.
In the United States, marketing life insurance policies as an investment tool is technically illegal. Nonetheless, many policyholders still use their whole life, universal life, or variable universal life (VUL) policies to increase tax-friendly retirement assets. Term life insurance policies do not establish a cash value.
The surrender value is the actual amount that the policyholder will receive when trying to obtain the cash value of the policy. Other names include surrender cash value, or in the case of annuities, annuity surrender value.
Early withdrawal of cash from an insurance policy usually results in penalties. In most cases, the difference between the cash value of your policy and the surrender value is the cost associated with early termination. Since your insurance company does not want you to stop paying premiums or request funds to be withdrawn in advance, it usually adds different fees and costs to the policy to prevent you from canceling the policy.
The surrender fee will reduce your surrender value. These costs and the surrender value of the policy will fluctuate throughout the life of the policy. After a period of time, the surrender fee will no longer be valid. At this point, your cash value and surrender value will be the same.
The process for you to obtain the cash surrender value varies depending on the policy you have, but many require you to cancel the policy before you can get the funds. Even in this case, you can still make a loan based on the cash value in the policy.
For whole life insurance or universal life insurance policies, the surrender fee is usually no longer valid after 10 to 15 years.
SECURE Act and surrender fees
Prior to the enactment of the SECURE per Communities Act in 2019, those holding annuities in employer-sponsored retirement accounts (such as 401(k) plans) may face the possibility of paying surrender fees and expenses. Job, or their employer stopped offering annuities as a retirement option. However, the SECURE Act establishes an annuity plan that is provided in a 401(k) portable way. This means that participants can transfer their annuity plan to another employer-sponsored plan or IRA without having to liquidate their annuity and pay surrender fees.
special attention items
Many people choose whole life insurance products that include cash value functions. With this function, part of the monthly premium is deposited into the cash account held in the policy. This cash accumulation is invested in approved funds and grows tax-free, which is why many policyholders use cash accounts as a form of retirement account. When used in this way, policyholders usually pay more than the required monthly premium to establish a tax-free cash account.
In 1988, the Technology and Miscellaneous Income Act (TAMRA) imposed restrictions on the cash held in these accounts. Called the seven-year payment test, it determines whether the premiums paid in the first seven years of the policy life cycle exceed the amount required to be paid to the account. If this total is greater, the account is considered a modified donation contract (MEC) and is subject to taxation of cash account proceeds as regular income.
Examples of cash value and surrender value
Suppose you purchase a whole life insurance policy with a death benefit of $200,000. After 10 consecutive years of payment on time, there is a cash value of US$10,000 in the policy. You check your insurance contract and see that the surrender fee is equal to 35% after 10 years.
This fee means that if you try to cancel the policy and withdraw the cash value after 10 years, the insurance company will charge $3,500 for your cash value and your surrender value is $6,500.
Why should you care about cash value?
Cash value is the money held in your permanent life insurance or an annuity that generates cash value. It is established when your insurance or annuity provider invests part of your premiums in bonds or other instruments. If you spend the money early, you will be punished.
What is the difference between surrender and cash value?
Suppose you decide to spend the money accumulated in your account. Costs will be assessed for this-the cost of surrendering the funds used, and there may be fines for early withdrawal. The surrender value is the amount you will get after you choose to terminate the policy.
How can I avoid paying surrender fees?
Most surrender fees will disappear after 10-15 years. However, insurance policies may vary from issuer to issuer, so it is important to understand the issue of surrender fees before completing the policy application and reading all policy disclosures in full.