What Are Surrender Rights?

Surrender rights refer to the ability to cancel an annuity or life insurance contract in exchange for its cash value. Surrendering such a contract early can incur surrender charges, which are fees charged by the company upon cancellation, as well as income tax liability.

Key Takeaways

  • Surrender rights allow holders of annuity or insurance contracts to exchange the contract back to the issuer for its present cash value.
  • Once the contract has been surrendered, it is considered null and void going forward.
  • Many such products have a specified surrender period, during which time a surrender will come with additional fees or charges.

Understanding Surrender Rights

Surrender rights are the right of contract holders to cancel a policy in exchange for its cash value. Before exercising a contract's surrender rights, contract holders should determine the contract's cash value, what fees and taxes will be incurred upon surrender, and how much cash they will ultimately net from canceling the contract.

In the case of life insurance, getting a life settlement in exchange for the life insurance contract may be a more lucrative option than surrendering the policy. Contract holders should also keep in mind that if they choose to repurchase a similar contract later on, the new contract may be more expensive, and not all annuities and life insurance policies have surrender rights.

Implications of Surrendering a Contract

If a policyholder surrenders a life insurance contract, for example, the life insurance company pays the surrender amount to the policy owner, however, the sum may be taxable, thus affecting the policyholder’s taxable income. In general, premiums invested in the policy are not taxable. However, the policy's returns through cash value, or the amount invested in an investment account that generates returns, are taxable. Surrendering a policy will end the life insurance coverage and terminate all rights and riders in the contract.

Another element policyholders should consider before surrendering a contract is whether or not such an action would carry a surrender fee. A surrender fee is a charge levied against an investor for the early withdrawal of funds from an insurance or annuity contract, or for the cancellation of the agreement. 

Surrender fees can apply for various time periods, ranging from 30 days to as many as 15 years on some annuity and insurance products. Surrender fees vary among insurance companies and among annuity and insurance contracts. A 10 percent charge levied upon the funds contributed to the contract for withdrawal in the first year is a pretty typical surrender fee. For each successive year of the contract, the surrender fee could drop by one percentage point, for example, effectively giving the annuitant the option of no-penalty withdrawal after 10 years in the contract.

Even though surrender fees typically decline over time, a decreasing surrender fee could still result in a larger penalty if the investment has grown over time. For example, a 10 percent fee applied to $100 is only $10, but if that $100 grows to $1,000 and the fee falls to 5 percent, the surrender fee would rise to $50.

Example of Surrender Rights

Tom has a 10-year $100,000 cash value life insurance policy with annual premiums of $5,000. After two years of premium payments, Tom loses his job and decides to surrender his policy. He stops paying his premiums and calls the insurance company to inform them that he has decided to cancel the policy. They send him a surrender form. He completes the form and sends it back to them. The insurance company charges him a 10 percent surrender fee and refunds him the premiums he has paid into the account along with the returns generated from his cash value account. The returned amount is taxed at ordinary income rates.