What is the Difference Between Accumulation Value and Cash Surrender Value?

The primary difference between accumulation value and cash surrender value is any applicable surrender charge to the life insurance or annuity contract.  Accumulation value is the full accumulated cash value in the policy.  Cash surrender value is the accumulated value minus any applicable surrender charge or market value adjustment (MVA).

It's important to understand, however, that surrender charges do not apply to all types of life insurance.  Additionally, surrender charges rarely last for the life of the insurance contract, so you should understand how surrender charges work to determine how they might affect the cash value in your policy.

Is Surrender Value the Same as Cash Value?

In some cases, the surrender value of a life insurance or annuity contract is the same as the cash value.  This is true for whole life insurance in almost all cases as that product does not normally have a surrender charge.  This is also true for some specials forms of universal life insurance and annuities that have no surrender charge.

But, when an insurance policy has a surrender charge that is active, the surrender value will be less than the cash value of the insurance policy.  This rule applies for the majority of universal life insurance and annuity contracts for the first several years of the policy.

Eventually, all surrender charges go away.  At this point, the surrender value and the cash value are the same.  When a life insurance or annuity contact has an applicable surrender charge active, we call this the surrender period.  When the surrender charge is no loner active, the surrender period is over.

For example, let's say you buy a universal life insurance policy with a surrender charge applicable for the first 10 policy years.  The surrender period of the policy is 10 years.

What is Total Cash Surrender Value? How is Surrender Value Calculated?

A life insurance policy's total cash surrender value is the difference between accumulated cash value minus any applicable surrender charge or market value adjustment.

For example, let's assume you have a universal life insurance policy with $20,000 of cash value.  The current surrender charge is 10%.  This means if you cancel the policy, the insurance company will keep 10% of the accumulated cash value.  In this example, the you will receive $18,000 upon canceling the policy.  The insurance company would keep $2,000 of the accumulated cash value.

If the policy had no surrender charge, then upon canceling the policy, you will receive all $20,000.  In this case, surrender value and cash value are the same.

Some life insurance and annuity contracts also have a market value adjustment applicable during the surrender period.  The MVA can appear like an intimidating formula to some.  The idea of a market value adjustment is pretty simple, however.  The MVA is simply an adjustment to the cash surrender value based on the movement in interest rates over a specific period of time detailed in the policy contract.

It's important to understand that not all market value adjustments reduce the surrender value of an insurance policy.  In some incidences, the MVA can actually increase the surrender value of a policy.  This happens because market value adjustments account for the change in bond values held by the insurer to produce the cash benefits of the insurance policy.

What Happens when a Policy is Surrendered for Cash Value?

When a policyholder decides to cancel his/her policy and the policy has cash surrender value, the insurance company will terminate the death benefit–and any other features of the policy–and pay the policyholder the cash surrender value.  The process generally takes place within a 30 day time period.

Generally speaking, the features of the life insurance policy remain in effect until the life insurance company sends the money to the policyholder.  This means that when a policyholder requests policy cancelation, the features of the policy remain in effect until the insurer processes the cancelation.

For example, let's say Jim contacts his life insurance company with a request to surrender his policy for its cash value.  The insurer needs time to process the cancelation of the policy.  Within that time period, Jim dies.  If the life insurer has not yet processed the cancelation request, it will pay Jim's beneficiary the death benefit of the policy.

If, however, the life insurer processes the cancelation request, mails a check to Jim, and Jim dies while the check is in the mail, his beneficiary will not receive the death benefit of the life insurance policy because it was cancelled before Jim died.

Usually, when a policy is surrendered for its cash value, the life insurer mails a check for the cash surrender value amount to the policyholder.  Some insurer might offer an electronic funds transfer, but there is still a majority preference to either mail a check or transfer the money via bank wire.

If the policy's cash surrender value equals an amount greater than the sum of premiums paid to the policy, this difference is taxable income to the policyholder.

For example, assume that Jim's policy has $100,000 in cash surrender value and to date he paid $75,000 in premiums.  $25,000 of the funds he received upon policy cancelation will count as ordinary income in the year he cancels his policy.  He will receive a 1099-MISC the following year that he'll need to file with his taxes and pay income taxes on this $25,000 of income.  Several life insurer do offer to withhold a percentage of the cash surrender value upon policy cancelation.  This withholding is sent to the U.S. Treasury as an advanced payment of the potential income taxes due.  This is an optional step in the policy surrender process.

If a policy surrender takes place during the surrender period, the surrender charge will reduce the accumulated cash value paid to the policyholder.  The remaining amount is the cash surrender value of the insurance policy.

For example, let's assume that on Jim's policy with $100,000 in cash value, there is a 10% surrender charge applicable to his policy.  If Jim cancels his policy he will receive $90,000 in cash.  This $90,000 is the cash surrender value of his policy.  Assuming that Jim's total premiums paid is still $75,000, now Jim will have $15,000 in income on which he'll owe taxes.  Jim does not get an income tax deduction for the $10,000 the life insurance company keeps.

How do you Avoid Surrender Charges?

The easiest way to avoid surrender charges it to keep your insurance policy in force until the surrender period expires.  For example, if you buy a universal life policy with a 10 year surrender period, you should keep the policy in force until at least the 11th policy year.  If you cancel the policy in year 11 or later, you will not pay a surrender charge on the policy.

Another option to avoid surrender charges is to use the free withdrawal amount option on an insurance contract.  This feature is fairly common on insurance contracts that contain surrender charges.  The free withdrawal amount is a percentage of the accumulated value a policyholder can withdraw from the policy without the surrender charge applying.  The most common surrender free amount is 10% of accumulated value per year.

To give you an example, let say you own a universal life insurance policy with $100,000 of accumulated cash value.  The policy also happens to currently have a 10% surrender charge applicable.  Your policy also has a surrender free amount of 10%.  This means you can withdraw $10,000 from the policy and you will not pay a surrender charge on the withdrawal.  You cannot withdraw any more money from the account until the next policy year without paying a surrender charge.

Lastly, you can also avoid surrender charges by using policy loans.  Policy loans are not subject to surrender charges, but when a surrender charge is applicable to a policy, it will affect how much of the accumulated cash value you can borrow against.  The maximum loan value will essential be the cash surrender value of the policy.

For example, if you own a universal life insurance policy with $100,000 in cash value and a 10% surrender charge currently applicable, you can borrow up to $90,000 from the policy.

Why the Difference Matters to Insurance Companies

Insurance companies use surrender charges to amortize the cost of acquiring a new insurance policyholder.  This means, they are spreading the cost of acquisition out across a number of years.  If the policyholder keeps the policy for the entire surrender period, the insurer recouped all of its expenses associated with acquiring the client and has no need to continue the surrender charge.  If the policyholder cancels the policy during the surrender period, the insurance company uses the surrender charge to recover expenses it incurred to acquire the client that it hasn't yet recovered.

The alternative to a surrender charge is simply assessing a large fee against the policy from the outset.  While this is an option to an insurance company, much marketing data suggests most insurance buyers dislike this idea.  So, to give consumers what they want, life insurance companies use surrender charges instead of initial charges assessed against policyholders.

You should understand that the accumulated value of a policy does benefit from all the life insurance policy has to offer.  So while you may not be able to take all of that money out of the policy if you cancel it, that money earns 100% of any accumulated interest applicable to the policy.

For example, assume you have a universal life insurance policy with $100,000  in accumulated cash value and $50,000 in cash surrender value of .  The universal life insurance policy earns 4% interest for the year.  This 4% interest applies to the entire $100,000 of accumulated cash value.

So keep in mind that accumulated value and surrender values matter to insurance companies because they represent the costs the insurer incurred to place the policy, but has not yet recovered.  Despite the surrender charge, you the policyholder still benefit from all the features of the policy, and any interest payable applies to your entire accumulated value.