What is a Surrender Fee?
A surrender fee is a cost you pay after canceling certain types of insurance policies, investments, or annuities. You may get hit with a surrender charge when giving up a life insurance policy, for example.
Why you pay a surrender fee
When you buy a life insurance policy, the insurance provider factors your premium payments into their revenue forecasts. In other words, they rely on your money (to an extent) because they plan for it.
As a result, when people cancel their life insurance policies, it can create a financial challenge for the insurer. If too many people canceled coverage at the same time, the insurer could struggle to overcome the dropoff in revenue.
This becomes especially true when people have permanent life insurance policies with a cash value component. When they cancel coverage, the insurer is obligated to pay out the policy’s cash value to them.
In an effort to prevent lost revenue compounding with cash value payouts, many life insurers institute a surrender fee, or surrender charge. This is a sum of money that the policy owner would need to pay upon giving up their coverage. The insurer hopes that the desire to avoid this fee will be enough to incentivize people to maintain their policies.
Decreasing surrender charges
Because the goal is to minimize unexpected revenue losses for the insurer, surrender fees usually dissipate over time. You may have a fairly steep surrender fee in the first few years of coverage that climbs down annually. Many life insurance policy surrender charges continue declining until they reach zero after a decade or two.
A big reason surrender charges start high and decrease with time stems from the way life insurance agents are paid. When an agent issues you a policy, the life insurer pays them a commission. The insurer then recoups that money as you pay your premiums through the years. If you cancel your coverage, though, they might be unable to break even. As a result, most surrender charges start relatively high.
Your insurer may give you a way to avoid surrender fees. Some insurers will waive these fees if the policy owner gives them enough advance notice before canceling coverage.
Surrender fees and surrender value
If you buy term life insurance, you’ll usually need to pay your surrender charge out of pocket.
If you have permanent life insurance, though, the fee generally gets subtracted from your policy’s surrender value. This is the amount of money that you’ve accrued within the policy’s cash value, minus the surrender fee and any other applicable deductions, like unpaid amounts on loans against your cash value. The surrender value is the amount the insurer pays you after you give up your policy.
If you plan to surrender a permanent policy for the cash value, look closely at the surrender charge structure. It may serve you to wait a year or two to lessen the percentage of the cash value that you’ll lose to your surrender charge.