Permanent life insurance offers financial protection in the form of a death benefit, and also offers a source of savings in the form of a cash value account.  The cash value account is the amount that your life insurance policy is worth, if you surrender or cancel it.  The life insurance company actually pays the cash to you if you cancel your policy.  Unfortunately, the cash value actually paid out if you cancel your policy can be reduced by surrender charges.  The net value of the cash minus any surrender charges, is called the surrender value.  Annuities also typically have surrender charges.

So What Exactly Are Surrender Charges

Surrender charges are the fees that your life insurance company takes out of your cash value, if you cancel your policy early.  Life insurance companies pay their agents a large commission when the policy is first sold.  To reduce their risk and recover some of the losses if a policyholder cancels early, they charge fees to the policy owner for early policy surrender.  Typically, surrender charges are highest in the first year or two or three, and then gradually reduce to zero over time.  It may take as long as 10 years for surrender charges to be completely gone.  Universal life insurance and variable universal life insurance typically have the highest surrender charges, and the charges last for the longest time.  Whole life insurance typically will have smaller charges, and term never has surrender charges because it has no cash value.  Annuities typically have seven to ten year surrender charge schedules as well, but some products may not have any.

How Expensive are Surrender Charges

Surrender charges are never charged in terms of dollars, but in percentages of cash value.  A high starting surrender charge is 10% to 12%, you typically do not see fees higher than this.  A lower starting charge may be 7% or 5%.  Eventually, the charge typically drops to 1% of cash value, and then 0% for the remainder of the policy.

While the fees are highest in the first years, the cash value is lowest.  The percentage that the company takes upon surrender drops in subsequent years, but the cash value grows substantially.  So keep in mind that in terms of real dollars, the company may be taking more money in later years than beginning years even with a lower percentage.

How do you Know What Your Surrender Charges Are?

You can ask your life insurance company for a schedule of your charges, in a document known as the surrender charge schedule.  Typically, the schedule will look something like this:

Surrender Charge Schedule

Policy YearsSurrender ChargeHypothetical Cash ValueHypothetical Total Surrender Charge
This is a hypothetical surrender charge schedule and how it may translate in terms of dollars. Note that the charges peak in the middle years as the cash grows and the charge hasn't yet dropped much. Eventually charges drop as the schedule moves towards 0.

If you have a policy with surrender charges, the insurance company should be able to show the schedule on your illustration, as well. When you are first quoted a price and policy value over time, it should also reflect these charges.

Are There Ways to Avoid Surrender Charges?

There are some ways to get cash from policy still in its surrender charge period, without paying charges.  You will not be able to access the entire value however.  The easiest way to take money is through a loan.  You can request a loan from your life insurance policy from the insurer, and they can give up to the amount stipulated in the contract without any immediate tax repercussions or surrender fees to you.  Usually you are allowed to borrow up to about 80% of your policy cash value, but the actual calculation may be a bit more complex.

You may also be able to avoid surrender charges through what is called a 1035 exchange, within the same company.  Basically if you take your policy value and transfer it into a new policy within the same company, the company may waive any surrender charges on your original policy.  They also may not, if the product that you are transferring into has a lower charge schedule than the existing policy.  You will need to clarify with your company prior to the 1035 exchange.  If you are moving the value over via a 1035 exchange between different companies, it is unlikely that surrender fees will be waived.

Be careful paying a lot of money into a policy in the early years, if you think it is possible that you will cancel the policy early.  You may end up paying the insurance company a hefty portion of your cash value if you are not careful.  You can always wait until the end of your surrender charge period, at which point charges typically disappear for the remainder of the policy life.

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