As the pandemic has impacted lives, the economy and livelihoods, 2021-22 has seen a surge in insurance policy surrenders before maturity. The data shows that more than 2.3 million life insurance policies were redeemed during the year – more than three times the number of policies (69.78 lakh) redeemed in 2020-21.
It is ironic that at a time when you desperately need your money, by redeeming a traditional contract (foundation or money back), the insured find themselves in the majority of cases with an even lower cash value than the premiums paid.
In the case of unit-linked plans, this may result in lower returns on capital investment. It is therefore very important to understand the pitfalls of quitting and to evaluate all the options before deciding to do so.
What should you look for before redeeming your policy?
The first thing to check is the cash value. “People often don’t check the cash value and assume the current value of the policy is what they will get if they surrender. Only later do they realize that what they received is much less than today’s value. So check the cash value before making the decision,” said Surya Bhatia, Founder of AM Unicorn Professional.
Advisors say policyholders should also assess the reason for surrendering the policy and the different options they can explore with insurance companies. Individuals should consider the reason for the buy-in — whether they need the money or think they can’t pay future premiums — and make their decision accordingly.
If one seeks to surrender the policy because one believes one cannot pay future premiums, the insured should reconsider.
“After completing the minimum premium payment period, you have the option to buy back or stop paying further premiums. policy decrease proportionally based on the reduced payment period, said Vishal Dhawan, founder of Plan Ahead Wealth Advisors.
“So,” he said, “if someone needs to control future cash flows, the individual has to explore the paid option. Often the paid options are not looked at by people, and they think they can either keep going or give up.”
If one is in need of money, one can consider taking out a loan against the policy, if the requirement is for a temporary period.
In cases where one seeks to redeem the policy to avoid asset class risk (stock market volatility) in the case of Ulips one has the option of moving money from the underlying fund to shares towards something that is debt driven.
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What are the impacts of surrendering a contract?
There are several pitfalls, including the loss of insurance coverage tied to the contract.
The biggest impact of a premature surrender is on the return you get from the policy, as the cash value is far less than what you can get at maturity.
There is no standard answer as to what a cash value may be – it depends on the type of policy (traditional or unit-linked), the years of premium paid and the length of the policy.
Financial experts say that in case of reimbursement, endowment and whole life insurance plans, individuals suffer severe losses when surrendering the policy and can lose around 50% of the premium paid.
In the case of Ulips, since they cannot be returned until the fifth year and can only be performed at the end of the sixth year, experts say there is not much loss. However, this impacts returns for investors due to the early termination of the policy.
Another impact is at the level of taxation. “People often miss the fact that even though the policy is tax exempt at maturity, if you redeem it before maturity, you miss it because it attracts tax at the marginal tax rate applicable to the individual insured,” Bhatia said.
Do you have to redeem your policy at all?
As the downsides of buyout are many, financial advisers suggest that it should be one of the last options. It is advised that when in need of money, investors carefully examine their entire investment corpus – mutual funds, insurance policy, term deposits, bonds, etc. – and after understanding the implications of dropping each one, they should understand which should go first and which should be resumed last.
“When you explore all the options and take a measured approach, you’ll end up making a better decision,” Dhawan said. He added that “while it can still be done with investment policies, it is crucial not to do it with futures policies.”
Bhatia said dropping a font should be the last resort. “Explore other options. Only in the case of Ulip plans, if the policy is not performing according to plan, you can seek to quit – but that too to reinvest in a better performing policy or another financial instrument “, did he declare.