Permanent life insurance offers lifetime coverage and acts as a means for wealth accumulation, where part of each premium goes towards building a cash value account. This account, accruing tax-deferred interest, grows gradually, offering access options like policy loans or premium payments. However, if you choose to terminate your policy, you can withdraw this accumulated cash value, known as the cash surrender value. But what exactly is this term, and why does it matter to you as a policyholder in Canada? Let’s dive into the depths of life insurance and unearth the secrets of cash surrender value.
What is Cash Surrender Value?
At its core, the cash surrender value is the amount you receive from your insurance company if you decide to terminate your policy before it matures or the insured event occurs. Think of it as a savings account within your life insurance policy; it’s a portion of the premiums you’ve paid that’s set aside and grows over time.
Which Types of Policies Have Cash Surrender Value?
Life insurance is broadly categorized into term and permanent types. Term life insurance, generally more affordable, is limited to a specific duration of usually 10-20 years without any cash value accumulation, meaning there’s no cash surrender value.
Conversely, permanent life insurance provides coverage for life, coupled with the advantage of accumulating cash value. Out of all permanent life insurance types, whole life and universal life policies are the most popular and the only ones accumulating cash value.
- Whole Life Insurance guarantees both premium and cash value growth, potentially enhanced by dividends in policies from mutual companies. Permanent or whole life insurance policies typically feature two cash value types: guaranteed and dividend. Both can be accessed by surrendering the policy or taking out loans, with dividend cash value exclusive to participating plans. The cash value grows at a rate the insurer sets and can be used for various financial needs.
- Universal Life Insurance, while typically less costly than whole life, lacks these guarantees and ties cash value to fluctuating interest rates. It offers adjustable premiums, but minimal payments over an extended period can affect the policy’s cash value and stability.
How is Cash Surrender Value Calculated?
The calculation of cash surrender value involves two main factors: the total premiums paid and any applicable surrender charges influenced by the policy’s duration. The cash surrender value is the difference between these two factors. In the initial years of a policy, the surrender value is typically low due to higher surrender charges, which can be as high as 35%. However, as the policy ages, these charges decrease or might not even be applied at all while the cash surrender value increases.
Cash Surrender Value in Canada: A Local Perspective
The concept of cash surrender value holds particular significance in Canada due to the tax implications. When you surrender your policy, the Canada Revenue Agency (CRA) views the cash value as income, subjecting it to taxes. However, it’s not the entire amount that’s taxed but only the portion that exceeds your policy’s adjusted cost basis (ACB).
How to Calculate Tax on Life Insurance Cash Surrender Value
Calculating the tax on the cash surrender value involves understanding your policy’s ACB. The taxable amount is the difference between the cash surrender value and the ACB. For instance, if your policy’s cash surrender value is $50,000 and the ACB is $30,000, you’ll be taxed on the $20,000 difference. In some cases, this tax could be deductible.
Cash Value Vs Cash Surrender Value
These terms sound similar, and the difference might need to be clarified. Cash value represents your policy’s accumulated funds, including compounded interest. The surrender value is this cash value minus any fees incurred upon surrendering your life insurance policy.
Can You Access Your Cash Value without Surrendering Your Policy?
Surrendering your life insurance policy has two main drawbacks: loss of coverage and potential fees reducing your cash value. However, there are a few alternatives:
- Withdrawal: You can withdraw cash tax-free if it’s less than what you’ve paid in premiums, but this may reduce your death benefit, possibly more than the withdrawn amount.
- Taking a Policy Loan: Borrow against your policy without affecting your credit rating. Interest rates are usually favourable, but unpaid loans reduce the death benefit.
- Paying Premiums with Cash Value: Use your policy’s cash value to cover premiums, keeping your coverage active. This is ideal for retirees prioritizing living expenses but risks policy lapse if the cash value is too low.
- Increasing Death Benefits: Use your policy’s cash value to boost the death benefit, preventing your funds from going to the insurer posthumously.
- Policy Sale: Sell your policy with substantial cash value for a one-time payment, typically higher than the cash value but lower than the death benefit. The buyer assumes premium payments and the death benefit. Be aware of potential taxes on amounts exceeding the policy basis and the time-consuming nature of life settlements.
For more specific details on these options and before making a decision, you should consult your insurance agent or company.
Making the Most of Your Policy’s Cash Surrender Value
To maximize the benefits of your policy’s cash surrender value, consider the following tips:
- Choose The Right Coverage: Opt for a permanent life insurance policy like universal or whole life for its cash value growth potential.
- Don’t Cancel Too Early: The cash surrender value grows over time. Avoid early termination of your policy to allow the value to accumulate.
- Pay in Time: Ensure timely premium payments.
- Invest More: Pay beyond the minimum premium to accelerate the growth of your policy’s cash value.
- Use Balanced Approach: Weigh the benefits of surrendering your policy against the potential loss of insurance coverage.
- Tax Planning: Seek advice from a tax expert to fully grasp the tax consequences and strategize accordingly.
The Bottom Line
When comprehended and strategically managed, the cash surrender value of life insurance can be a significant asset in your financial arsenal. Understanding the cash surrender value is crucial whether you’re considering policy termination or simply exploring your options. Remember, life insurance is more than just a safety net for your loved ones; it’s a versatile financial tool that, when used wisely, can significantly impact your financial well-being.