What is Surrender Value in Life Insurance & How to Calculate?

There may be some causes driving you to stop paying the premium of your life insurance policy in the middle of the term. Since you have paid previous premiums until that date, you may wonder whether you can claim any sum from your insurance company.

In such a scenario, you can get a surrender value from the insurer. So, let’s look at what surrender value is, along with some must-know factors related to it.

Surrender value is an amount that insurance companies give their customers if they terminate their policy before the maturity period. If they opt out of their plans mid-term, they will get the total amount accumulated towards savings and the interest accrued on them. 

Nevertheless, insurance companies only give the sum after deducting a surrender charge from the total fund value.

The surrender value, or cash value, is the amount of money the policyholder will receive if they decide to cancel their policy prematurely, or the surrender value of a claim is based on the policy quality, terms, fees, and any fees or penalties.

Here are the two key elements of it:

• Understanding Surrender Value: Generally, all life insurance accumulates cash value over time, while universal life insurance offers greater flexibility in premiums and death benefits. However, term life insurance does not accumulate monetary value.
• Types of Life Insurance: Surrender fees, credits, or withdrawals can also affect surrender value. After five years, the policy documents must be reviewed to obtain a fair value offer, and the insurance provider can provide a detailed breakdown.

The surrender period is when a policyholder cancels their policy and receives the surrender value without incurring significant penalties or surcharges. It varies by insurance company and is based on the specific terms established by the insurance company.

Typical surrender periods range from a few years to over a decade, with many plans having a 5- to 10-year commitment period. The cost of surrender is the amount paid by the insurer if the claim is surrendered within the deadline. These charges usually decrease over time and eventually disappear at the end of the season.

An Example of a Surrender Period

For example, the plan may receive a cash advance of 10% of the cash value in the first year, decreasing by 1% per year until it reaches 0%. Policyholders who surrender their policies within the surrender period will receive less than the total premium due to this surrender.

After the surrender period, policyholders can generally receive the total value without paying a surrender fee. Understanding the timing is essential for financial planning, as it helps policyholders make informed decisions about when they will receive their policy's cash value and avoids unnecessary penalties.

Note: Timing and comparing premiums can be essential when choosing insurance policies. Always check the insurance policy specifications to understand the timing and associated fees.

Now that you understand the surrender value in a life insurance plan, you will also need to know its types.

There are two major types of surrender value, as mentioned below:

1. Guaranteed Surrender Value

2. Special Surrender Value

Policyholders get a special surrender value if they stop paying premiums, but they do not request to surrender their life insurance plans. In such circumstances, the life cover stays in effect, and resultantly, the sum assured amount keeps decreasing with time. In such a scenario, they get a paid-up value instead of the sum assured amount.

When individuals surrender these policies, their insurers calculate the surrender value by multiplying the paid-up value by the surrender value factor and adding bonuses, if applicable.

Here, Paid-Up Value = Sum Assured x (Number of Paid Premiums / Number of Total Payable Premiums)

You can understand how the guaranteed and special surrender values work with the examples below.

The surrender value factor is a ratio of the total premium policyholders have already paid and the total premium they will have to pay until their terms end. It is expressed in percentage value.

Let’s assume that the premium amount is ₹ 10,000/year and that you have continued making policy payments annually for 5 years. If the policy's term is 20 years, the surrender value factor will be (5/20) x 100% = 25%.
For better clarification, examples delineating how guaranteed and special surrender value is calculated have been mentioned below.

Calculating Guaranteed Surrender Value in Life Insurance

Calculating Special Surrender Value in Life Insurance

Let’s consider that a policyholder has purchased a policy having a term of 20 years, and the premium amount is ₹ 10,000/year. The sum assured amount is ₹ 5 Lakhs. The policyholder then wants to stop paying policy premiums after 5 years.

In this circumstance, the paid-up value = ₹ 5 Lakhs x (5/20) = ₹ 1,25,000

If he/she wants the special surrender value after 10 years, the surrender value factor will be = (10/20) x 100% = 50%.

So, after 10 years, he/she will get a special surrender value of ₹ 1,25,000 x 50% = ₹ 62,500.

Surrendering your policy allows you to access the cash value before the policy's maturity. To claim the surrender value of your life insurance policy, follow the steps below:

• Step 1: First, you must review your life insurance policy for details on surrender value and any associated penalties.
• Step 2: Once you’ve reviewed the policy details, inform your insurance company or agent about your decision.
• Step 3: You will receive a surrender request form either online or in person. Fill out the form with the required information.
• Step 4: Submit the form with the original policy document, identification proof, and bank details. You can do this both online and in person at a branch.
• Step 5: Follow up with the insurer to check the status of your request. Once processed, the surrender value will be transferred to your account.

You will not get any surrender value from a plan that offers no maturity benefit. Since term plans do not have any maturity benefit, the insurance companies do not keep any portion of your premiums towards savings or funds for investment.

Term plans have no surrender value. This surrender value can be obtained on life insurance policies like endowment plans or ULIPs.

Due to the mid-way termination, insurance companies deduct a surrender charge from that claimable sum. It varies from one insurance company to another. You can also learn about the surrender charge from the policy brochure you get when purchasing it.

Nevertheless, according to IRDAI's mandate, insurance companies cannot apply this surrender charge if customers liquidate the fund values of their life insurance plans after 5 years of purchase.

Step 1: Wait Until the Surrender Period Ends

Step 2: Use Policy Loans or Withdrawals

Step 3: Review Policy Terms

Step 4: Compare Policies with Low Surrender Charges

Step 5: Consider Policy Exchange or Conversion Options

Step 6: Use the Free-Look Period

Step 7: Negotiate with the Insurance Company

You can discuss with the insurance company to negotiate lower surrender charges or explore alternative solutions.

By avoiding surrender charges, policyholders can maximize the value of their insurance policy and avoid penalties.

Below are the financial impacts of claiming surrender value on investment:

• Compound Interest Growth: A life insurance policy's profit or maturity value grows in compound interest. This is why, when you keep your investment unharmed until the end of your policy term, you enjoy a maximum benefit due to the effect of compounding.
• Surrendering Early: In the opposite scenario, when you raise a claim for the surrender value or withdraw it before time, it fails to accrue much interest. Your insurance company will return you the total savings or aggregated fund value.
• Interest and Charges: You will get whatever interest you gain from it. You must also remember the surrender charge that the insurance company will deduct. This is why the potential gains on your funds get reduced when you surrender your policy.

Now that you know what a surrender value is, you can infer that even though you had to terminate your life insurance policy mid-way, you will get back a certain amount.

The insurance company will give you the amount it sets aside for savings and the interest accrued. Nevertheless, this facility is available only on life insurance policies with a maturity value.

Yes, you must pay tax if you surrender your life insurance policy. This is because surrendering a life insurance policy can have tax implications, depending on the policy type, cash value received, and total premiums paid. The difference is considered taxable income if the cash surrender value exceeds the total premiums paid.

Policies with outstanding loans or withdrawals may also affect the taxable portion. Surrender charges can reduce the cash value but not directly affect the taxable portion. To manage tax liability, consult a tax professional, explore policy loans or withdrawals, and plan for the tax event.