Do I Pay Life Insurance Surrender Charges?

Surrender charges disappear over time.

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Sophisticated life insurance products such as universal life allow you to build a policy with an element of savings on top of your financial security protection in case of premature death. The advantage of building a savings component is that investment earnings inside the life insurance contract are not taxable. You generally pay taxes on investment earnings only when you make a withdrawal, which is also the only time you might have to pay a surrender charge.

Surrender Charge

Life insurance companies typically levy a surrender charge on withdrawals made in the early years of a policy so they can recuperate costs incurred when the policy was opened, such as agent commissions and underwriting expenses. Surrender charges will be displayed in your policy contract and are usually expressed as a percentage of the policy account value. They generally last for a specific period, such as 10 or 15 years, and may follow any kind of pattern that the insurance company decides on. A typical pattern is a decreasing surrender charge until the charge disappears.


Your policy’s account value keeps track of your premiums and investment earnings, as well as deductions for the insurance element of the policy plus fees for administration expenses. If you cancel your policy, the insurance company will pay you what you have accumulated in your policy account, minus any applicable surrender charge for the year in which you make your request.


If you wish to only withdraw a portion of your policy’s account value, the company will typically impose a surrender charge on a pro rata basis. If your surrender charge was 50 percent of the accumulated value, then a partial withdrawal would incur a similar 50 percent surrender charge. If you requested a $2,000 partial withdrawal, for example, the insurance company would pay you a net amount of $1,000 and deduct $2,000 from your policy account value.


Withdrawals from an insurance policy are typically taxable and they generally reduce your insurance amount. If your strategy is to maximize returns and leave money behind for your beneficiaries, such withdrawals are disadvantageous. As an alternative, consider assigning your policy to a bank in exchange for a loan. Because the loan is a third-party arrangement, it will not affect your policy values. In addition, bank loans are typically not treated as taxable income. You will avoid paying surrender charges and the bank receives a portion of the tax-free proceeds to cancel the loan at your death. Any remaining proceeds are paid to your named beneficiary tax free.