Charges to consider in surrendering insurance policy

Surrendering an Insurance policy??

When a life insurance policy is surrendered, the owner is canceling the policy for the “nonforfeiture value,” a predetermined sum of money (the surrender value). After paying out the surrender value, the insurance company that provided the coverage is no longer obligated to provide life insurance benefits to the (former) policy owner. That is, by surrendering a life insurance policy, the policy owner gives up all rights under that policy, including any death benefit payable under the policy.

Life insurance comes in two basic forms: cash value (permanent) and term. By its very nature, term insurance is temporary and generally does not build cash value. Since term life policies generally have no surrender value, they will not be discussed here. All further mention of life insurance in this article refers to cash value life insurance.

The surrender value is determined by adding any accumulated dividends and unearned premiums to the current cash value amount and subtracting any outstanding loans (or loan interest), and any surrender charge. To obtain the current surrender value or surrender charge, contact the insurer that issued the policy. Typically, the cash value will increase and the surrender charge will decrease as a policy ages. At some point, which can be as long as 15 to 20 years, the surrender charge will usually disappear.

There is generally a price tag attached to surrendering a life insurance policy – it’s the surrender charge. The surrender charge is the fee or penalty a policy owner agrees to pay for terminating the policy early. It is a predetermined amount typically figured as a percentage of the cash value portion of the policy.

Just as there are many reasons to purchase insurance, there are many reasons to surrender it. The reason to surrender a life insurance policy is generally straightforward – gaining access to cash.

Many people choose to surrender a policy when the reason they bought life insurance ceases to exist.

In surrendering his or her life insurance policy, the policy owner is giving up all rights under the policy, including his or her right to claim the death benefit. But even if the policy owner feels there is no current need for life insurance, it is possible that a future need for life insurance will resurface. If so, the ability to purchase a new policy will depend on the individual’s circumstances at the time (e.g., the individual’s age and health).

Additionally, there are surrender charges to consider, which can be high in the early years of the policy, causing the surrender value to be reduced. Finally, there are tax consequences to consider. If the surrender value 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.

Unless otherwise stated in the policy, a policy owner has the right to borrow against the accumulated cash value in the life insurance policy. By borrowing, the policy owner can get money from the policy without having to surrender it. The policy may even offer a better interest rate than banks are offering. This is not a typical loan, however, because it never actually has to be repaid. Any outstanding loan balance will be subtracted from the death benefit or future surrender value.

Taking a withdrawal from the cash value portion of the life insurance policy is another option. This is also known as a partial surrender. Unlike a loan, a withdrawal will permanently reduce the death benefit, but there are no interest payments as there are with policy loans. There will, however, be a tax on any withdrawals that exceed the cost basis in the policy.

If the policy owner ceases premium payments, the accumulated cash value in the policy will be used to pay premiums and the policy will eventually lapse (after the stated grace period expires), unless the cash value is great enough to generate dividends or interest sufficient to sustain the policy.

Depending on the type of cash value policy one has, failure to pay premiums may cause the death benefit to be reduced, leaving the policy owner with a “reduced paid up” policy. Or, the life insurance company may give the policy owner an extended term policy for a designated number of years, months, and days that requires no future premium payments.

Should the policy lapse, the accumulated cash value will be forfeited. However, no income tax liability will be incurred, and no surrender charges will be due.

When an individual surrenders a policy, any gain will generally be taxed as ordinary income. Gain can be calculated by subtracting the policy basis from the cash value, which includes any terminal dividends and unearned premiums. Basis represents the policy premiums that the policy owner has already paid (reduced by any amount withdrawn).When replacing or exchanging one cash value life insurance policy for another, it is possible to defer any taxable gain resulting from the surrender of the original policy.

• Please send any financial questions you wish to have answered in this column to Dorion-Gray Retirement Planning Inc., 2602 Route 176, Crystal Lake, 60014. You may also fax them to 815-455-4989 or email Paula Dorion-Gray , CFP, is a Registered Representative of Securities America Inc., member FINRA/SIPC.

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