Consider loss of cover, deductions before surrendering life insurance plan

If your income is likely to revive soon, consider taking a loan against the policy instead of surrendering it

According to media reports, over 23 million life insurance policies were surrendered by policyholders in 2021-22, three times the number surrendered in the previous financial year. This happened chiefly due to the financial distress caused by the Covid-19 pandemic. While those were exceptional circumstances, in normal times policyholders should surrender policies after a lot of deliberation.
 

Lapsed versus surrendered policies
 

Lapsed policies are those on which you have missed paying a premium or two. It’s possible to revive them by paying the premiums, plus some interest and penalty.
 

Surrendered policies are those where the insured has requested the insurer to terminate the policy and collected the accumulated surrender value. “A surrendered policy can’t be revived,” says Atri Chakraborty, chief operating officer, IndiaFirst Life Insurance.
 

However, if you have bought a policy from the Life Insurance Corporation (LIC) of India, check the terms and conditions. “In case of an LIC policy, you may be able to reinstate a surrendered policy within six months. If the surrender value has not been transferred to your bank account, there could be an automatic reinstatement,” says Apaar Kasliwal, executive director, PolicyBoss.com.
 

When is it okay to surrender?
 

If you are in financial distress, you have no choice. A life insurance policy may also be surrendered if you believe it is not right for you. “You may have wanted a term insurance policy, but were sold a whole-life policy that requires you to continue paying the premium till the age of 90 or 100, which you may not want to,” says Arnav Pandya, founder, Moneyeduschool.

You may also exit if you think the surrender value you will get from the policy can be invested in another policy for higher returns. “In today’s rising interest rate scenario, non-participating policies are promising higher guaranteed returns than they did a couple of years ago,” says Kasliwal.
 

A term policy may not make sense after a certain age. If you have taken care of all your liabilities, or the wealth you have accumulated is sufficient, you may terminate the policy.
 

“In a term policy, people also surrender when term premium rates are falling and they can buy another policy at a lower price,” says Naval Goel, founder and chief executive officer (CEO), PolicyX.com.   
 

High cost of surrendering
 

In most situations, however, surrendering is not a good option. “If you decide to exit early, the insurer will apply a discounting factor to the value accumulated in the policy to arrive at the surrender value,” says Kasliwal.
 

A traditional policy usually doesn’t acquire any surrender value in the first two years. “If you surrender in the third or fourth year, you may get only 30-40 per cent of the total premium amount paid,” says Kasliwal.
 

Goel explains that the surrender value is very low in the initial years because insurers have to bear high upfront costs, such as agent’s commission.  
 

Other benefits also end. “The life cover meant to provide financial security is lost, as is the tax benefit,” says Chakraborty.

When you buy a term plan at a young age, you get it at a lower premium, which remains constant. “If you surrender a policy now and go to buy it later, the mortality charge will rise because it is determined by your age slab,” says Chakraborty.
 

Ulips come with a lock in
 

A policyholder can’t exit a unit-linked insurance policy (Ulip) before five years. If he stops paying the premium before five years, the accumulated fund value is not paid out. Instead, it goes into a policy discontinuance fund where it earns a nominal interest of 4 per cent. The fund value is paid out after five years. Therefore, your immediate liquidity needs won’t be addressed by surrendering a Ulip before five years.
 

Before surrendering a Ulip, understand its costs. “If fund performance is poor and the costs high, exit,” says Pandya.

Consider partial withdrawal
 

In a Ulip, the customer can do partial withdrawal to meet his short-term cash requirement. “This is permitted after five years,” says Chakraborty.
 

Another option is to make the policy paid-up. Traditional policies can usually be made paid-up after the third year. Suppose you have paid three premiums of a policy with a 10-year premium payment term. All the benefits accruing on that policy, such as sum insured, expected returns, etc will reduce proportionately to 30 per cent.
 

The benefit of making a policy paid-up is you don’t incur heavy losses, as you do when you surrender.

A paid-up policy can be revived. “You can do so within three years in a Ulip and five years in a traditional policy,” says Chakraborty.  
 

Borrow against the policy
 

Instead of surrendering, you can take a loan against the policy’s surrender value. “By taking a loan, you can address your immediate need for funds. This will also ensure you don’t lose out on the policy’s future benefits,” says Chakraborty.

However, calculate if taking a loan makes more sense than surrendering the policy. “First, find out the surrender value and accrued bonuses. Compare it with the sum assured and also the maturity value. Also compare the surrender value with the premiums paid to understand what you will lose,” says Pankaj Bansal, chief business officer, BankBazaar.com. Next, factor in the interest outflow on the loan.
 

Taking a loan against policy has another cost. “In case of a claim, the principal and interest will be deducted from the policy’s pay-out and only the balance will be paid to the nominee,” says Bansal.

Motive for buying policy should govern surrender decision
 

1. Did you buy the life policy to protect your family against the risk of early death of the breadwinner? If your liabilities are taken care of, or you have sufficient savings to take care of them, you may terminate the term policy.
2. Did you buy the policy for legacy planning (to pass on wealth to the next generation)? In that case, continue paying the premium on the whole-life policy.
3. If you had bought for the purpose of investment, then take into account how much money you will get in hand, and whether it can be invested elsewhere to earn a higher return over the same period.