September 02 , 2013
Majority of the people who seek our assistance for term policies are those who already have life insurance policies, only that they do not serve their needs. Most of such policyholders lament how the agent or adviser (mostly agent doubling up as adviser) duped them. The returns they've made so far nowhere resembles illustrations they had been shown then.
Call it mis-selling on agents' part or ignorance and blind trust on buyers' part but numerous people now are waking up to their insurance mistakes. If you feel you have ended up with the wrong life insurance policies read on to know if it is best to surrender now, make paid-up or stay with the policy.
How do the numbers look?
The decision to surrender, make paid-up or continue a policy till term end completely depends on whether you would get better returns on premiums invested and to be invested by moving out of it or staying put. Here we will deal with traditional endowment policies- the ones that have a life cover as well as fixed maturity benefits. ULIPs are a different case; we will look at them later.
To make a policy paid-up means to simply stop paying premiums. The policy does not cease. You get a reduced cover on death or at maturity. On the other hand to surrender a policy means to return the policy and walk off with whatever little payout you get, hopefully to invest in other avenues where they'd earn better.
Figure out the paid-up value
Paid-up value acquires after paying premiums for certain minimum number of years. Right now this is 3 years. This value is proportional to how many premiums have been paid so far.
Paid-up value = (No of premiums paid/Total no of premiums payable)* Sum assured
Vested bonuses are also added to this value but in some policies only after 5 premium payment years have been completed. Also you can observe that premium amount does not figure in the paid-up value calculation however the sum assured depends on premiums so it automatically is taken care of.
Next figure out surrender value
Surrender value is what you'd get if you return the policy midway. If surrendering after 3 years then what you get is a discounted portion of paid-up value and bonuses accrued till date. This is covered in detail in the article How to Calculate Surrender Value. If surrendering before 3 years you get 30% of premiums paid less first year premium (you read that right!). This is the minimum amount you would get, even on policies surrendered after 3 years.
Surrendering vs making paid-up policy
Part of the number crunching is done. Now you know how much payout you can expect to get if policy is made paid-up or if it is surrendered. Depending on how many years you're into the policy, paid-up value could be less than surrender value or vice versa. But if there is a condition playing in your favour you would be better off surrendering policy and investing the proceeds elsewhere. The condition is that you can earn higher returns elsewhere than what the policy would pay within policy maturity period. If this is not true it would be better to make the policy paid-up instead of surrendering it.
An example should make this easier to understand. Take a 30 year LIC endowment policy of sum assured Rs 15 lakhs whose annual premium works out to Rs 25,000. Suppose the policy holder stops payment after 6 years. Her paid-up value would be Rs 3 lakhs, which she'd receive at maturity or on death before that. For calculating surrender value let's assume yearly bonus @ 4% making total accrued bonus in the 6 years to Rs 3.6 lakhs. Surrender value factor of 30 year term LIC endowment policies in the 6th year is 18%. So surrender value works out to Rs 1.2 lakhs (18% of 3+3.6 lakhs).
Rs 1.2 lakhs can be invested in an FD giving 8.5% for the remaining 24 years of the policy term to get Rs 8.9 lakhs at maturity. Maximum FD term is 10 years so she'd have to roll it over or invest in bonds/debt mutual funds. In this scenario it makes better financial sense to surrender policy than to make it paid-up. The reverse can turn out be true if some of the inputs above are tweaked. The maths will tell you whether to stay put or leave now.
Tax implications of surrendering policy
If you have claimed 80C deduction on premiums paid these will be reversed, in the sense the amount of tax rebate claimed will be added to your income in the year of surrender. This clause is applicable for non-ULIP policies surrendered before premiums for 2 years have been paid or in case of single premium policies if surrendered within 2 years of policy start date. You would have to pay tax on this amount so subtract this from surrender value, if it applies to your case.
Besides in case of policies issued on or after 1 April 2003 if premium paid is more than 20% of sum assured or 10% in case of policies issued on or after 1 April 2012 the amount received as surrender value would be taxable as per section 10(10D) of the Income Tax Act.
To surrender, make policy paid-up or continue till term end depends on payouts which basically depend on how many premiums years are over, how many are left and the policy term. Find out from the insurer itself what the exact paid-up value and surrender value would be.
1. If you realize you have a worthless policy after paying premium for 1 or 2 years it might be better to surrender policy with whatever measly sum you get instead of paying 3rd premium to make it a paid-up policy.
2. If the realization dawns after 3 or more years then you need to do the math to figure out whether surrendering or making paid-up works out better, considering cancelling of 80C benefits if this is less than 5 years.
3. Towards the end of policy term it usually makes sense to continue.
What next? If you decide to surrender existing life insurance policy or make it paid-up don't risk being un-insured or under-insured. Buy adequate term cover and channelize money from the remaining saved premiums to the best investment products suited to your goals and life stage.