If you read the contract for your annuity or permanent life insurance policy, you will encounter insurance industry terms that sound similar but mean very different things. This is the case with terms such as face value, cash value, cash surrender value, surrender cost and account value. The differences between these concepts are sometimes small, but they can make a large difference if you need to pull money from your policy.
The Basics of Cash Value
Cash value, or account value, is equal to the sum of money that builds inside of a cash value-generating annuity or permanent life insurance policy. Your insurance or annuity provider allocates some of the money you pay through premiums toward investments — such as a bond portfolio — and then credits your policy based on the performance of those investments.
In the United States, it is technically illegal for a life insurance policy to market itself as an investment vehicle, but many policyholders use their whole life, universal life or variable universal life insurance policies to grow tax-advantaged retirement assets. Term life insurance policies do not build cash values.
The surrender value is the actual sum of money a policyholder will receive if he tries to access the cash value. This is also referred to as the surrender cash value or, in the case of annuities, annuity surrender value. The cash value and surrender value are not the same as the policy's face value, which is the death benefit. However, outstanding loans against the policy's cash value can reduce the total death benefit.
Cash Surrender Value
Cash Value Minus Surrender Costs
In most cases, the difference between your policy's cash value and surrender value are the charges associated with an early termination. Since your insurance provider does not want you to stop paying premiums or request an early withdrawal of funds, it often builds into its policies different fees and costs to disincentivize you from canceling your policy.
The surrender costs reduce your surrender value. Costs and value can both fluctuate over the life of a policy, which leaves policyholders with two methods of maximizing the surrender value. The first is to hold onto the policy longer and make premium payments on time. This is the primary and traditional way.
It is also possible to pay more than your scheduled premium. This second option is especially effective with universal or variable universal life insurance policies. You have to ensure your contributions are within the limits of the modified endowment contract (MEC) to avoid higher taxes because you've lost your qualified status. Some insurance contracts do not allow this option.
After a certain time period — normally 10 to 15 years for a whole life or universal life insurance policy — the surrender costs will no longer be in effect, and your cash value and surrender value will be the same. The process through which you access your cash surrender value varies based on the policy you have, but many require that you cancel the policy before accessing the funds. Even if this is the case, it may be possible to take a loan out against the cash value in your policy.
An Example of Cash vs. Surrender Value
Suppose you purchase a whole life insurance policy with a death benefit of $200,000. After 10 years of making consistent, on-time payments, there is $10,000 of cash value in the policy. You consult your insurance contract and see that the surrender charge after 10 years is equal to 35%. This means if you tried to cancel your policy after 10 years and withdraw your cash value, the insurance provider will assess a $3,500 charge to your cash value, leaving you with a surrender value of $6,500.