Your life insurance options include a choice between term and permanent insurance. Term insurance is less expensive but provides insurance protection only. Permanent plans offer the additional feature of accumulating cash value. You can access the cash while the policy is still in force, and you also have the option of surrendering the policy, which is sometimes referred to as "cashing it in."
Cash Value
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As you pay premiums on a permanent life insurance plan such as whole life, universal life or variable life, a portion of the payment goes toward the cost of the insurance and any administrative fees assessed by the company. The balance goes into a cash accumulation fund, which accrues interest over time. You can access the available cash in the form of a low-interest loan or a straight withdrawal, depending on the type of policy.
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Cash Surrender Value
The insurer sells the policy with the idea that you will continue to pay the premiums until your death. If you decide to cash the policy in early, the insurer will attempt to recoup some of its loss by issuing a surrender fee, which it subtracts from your accumulated cash value.The amount of the fee depends on how long the policy has been in force. The remaining balance is known as the policy's cash surrender value.
Presence of Coverage
The primary difference between a policy's cash value and the cash surrender value is that with the former, you can withdraw funds and still maintain coverage, while the latter means the termination of your policy. When you withdraw money from the cash value, you are not obligated to pay it back, although any outstanding balance plus interest will be subtracted from the death benefit paid to your beneficiaries. If you surrender a policy and decide to get coverage at a later date, you'll pay a higher premium due to your advanced age.
Tax Considerations
A benefit of borrowing against the cash value of an insurance policy instead of cashing it in is that, in addition to maintaining insurance, you typically are not taxed on the amount of the loan. If you surrender the policy, you'll generally be required to pay taxes on any amount that exceeds the total value of the premiums you've paid over the years. If you've owned the policy for many years, the tax hit could be significant.