When you cash surrender a universal life insurance policy, you end the contract, give up the death benefit, and receive the policy’s net cash value. The insurer subtracts surrender charges and any unpaid loans from the gross cash value before sending you a check, and you owe ordinary income tax on any amount that exceeds what you paid into the policy.
How Much Money You Actually Receive
The gross cash value, the total built up from premiums and interest, is not what lands in your account. The insurer subtracts two things to arrive at the net cash surrender value: surrender charges and any outstanding loan balance, including accrued interest.
Surrender charges cover the insurer’s costs of putting the policy in place. They are usually highest in the first few years and typically phase out after 10 to 15 years. If you have borrowed against the policy and not repaid the loan, that balance comes off the top automatically. The remainder is paid to you.
How the Payout Is Taxed
Death benefits generally pass tax-free, but a surrender payout can be taxed as ordinary income.1Internal Revenue Service. For Senior Taxpayers 12Office of the Law Revision Counsel. 26 U.S.C. § 101 You only pay tax on the portion that exceeds your investment in the contract.
The IRS defines your investment in the contract as the total premiums you paid, minus:1Internal Revenue Service. For Senior Taxpayers 1
- Refunded premiums
- Rebates or dividends
- Loans that were not repaid and were not already included in your income
If your net payout is less than your investment in the contract, you are recovering your own money and generally have no taxable gain.1Internal Revenue Service. For Senior Taxpayers 1 If it exceeds that figure, the difference is taxable as ordinary income in the year of surrender.
If Your Policy Is a Modified Endowment Contract
A policy becomes a Modified Endowment Contract (MEC) if it fails the 7-pay test, which happens when too much money is paid in during the first seven years.3Office of the Law Revision Counsel. 26 U.S.C. § 7702A MEC status changes the ordering rule. In a standard policy, the IRS treats your own contributions as coming out first, which keeps early withdrawals tax-free. In an MEC, taxable earnings are treated as coming out first, so they are taxed immediately.4Legal Information Institute. 26 U.S.C. § 72
If you surrender an MEC before age 59½, an additional 10% penalty tax applies to the taxable portion.5Office of the Law Revision Counsel. 26 U.S.C. § 72 Loans against an MEC are also treated as distributions and can trigger tax right away.
How to Request the Surrender
Contact the insurance company and ask for its surrender package. The form typically requires your policy number, your signature, and payment instructions. Some insurers require a Medallion Signature Guarantee, a stamp issued by a bank that verifies your identity, and a copy of a government-issued ID.
Processing usually takes 7 to 15 business days, with funds paid by check or direct deposit. After the payout, the insurer sends IRS Form 1099-R showing the total distribution and the taxable portion. Use that form when you file your income taxes for the year.1Internal Revenue Service. For Senior Taxpayers 1
Alternatives Worth Considering Before You Surrender
Full surrender is not the only way to deal with a policy you no longer want to fund.
A Section 1035 exchange lets you move the cash value directly into a new life insurance policy or annuity without recognizing the gain. The funds must transfer directly between insurers; you cannot take possession of the money.6Office of the Law Revision Counsel. 26 U.S.C. § 1035
Two other options:
- Reduced paid-up status uses the existing cash value to buy a smaller, fully paid policy, ending premium payments while keeping some death benefit in place.
- A policy loan lets you borrow against the cash value. Loans are generally not taxed when taken, but they can become taxable if the policy lapses or is an MEC, and they accrue interest and reduce the death benefit.4Legal Information Institute. 26 U.S.C. § 72