Many people just starting their professions were first exposed to insurance policies by family members or friends, who encouraged them to purchase insurance policies as an investment and a way to save taxes.
But once they understand that the Investment in Insurance not only offers low returns but also does not provide adequate insurance cover, the policyholders do have questions like – whether to surrender the policy and invest in other investment products or buy a term plan by surrendering the existing insurance policy, etc.
It seems sense to feel that way considering that you have invested your hard-earned money and, by signing a long-term contract with Insurance Company. Further, you have also committed to paying premiums, earning “poor returns,” and receiving very little life insurance coverage.
In the very first step, let’s understand why Traditional Insurance (for investment purposes) is not the best option for most investors.
- In most of cases, Insurance Companies provide illustrations of 7%-8% returns for the long term. However, due to the complex and high-cost structure of Insurance Companies, investment in insurance can offer up to 4%-6% returns over the long term. Due to the poor returns and lower coverage, many investors used to surrender the policies.
- The time value of money is another factor. That is to say, what would happen if someone chose to stop losing money, gave up their insurance policy, and made investments elsewhere in expectation of earning higher returns? Will the transaction provide inflation-beating returns in addition to compensation for loss?
Many investors may argue this, claiming that even after the policy matures, the nominee is still eligible for guaranteed death settlements. However, as we consider this policy as an investment, we are evaluating returns through the policy’s maturity. The best type of insurance is a pure term plan, but Insurance agents would never tell you that because of the small fees they receive on that. However, if we were to discuss the premium paid and life cover of traditional insurance investments, it would not be able to compete with that.
Let’s come to the main question.
Should I surrender my Traditional Insurance Policy?
The majority of insurance policies (money-back and endowment) allow for surrender at any moment following two to three complete years of premium payments. You will receive a refund for certain (proportionate) of your premiums paid, less surrender charges (if any), if you turn in the insurance before that period of its whole term. Surrender value is the amount of money you receive back after surrendering.
Finding the appropriate life insurance coverage for yourself should be your first step, after which you should purchase basic term life insurance policies. It offers substantial protection at a reasonable price. It is necessary to complete this first, non-negotiable stage before giving up on your insurance policy. Don’t ignore it or assume that the employer’s life insurance is sufficient. Purchase a term plan right away.
Now for another illustration. Assume you pay a premium of Rs 50,000 per year for a standard insurance policy with a 25-year term. After accounting for all bonuses and other increases, your maturity amount, assuming 6% maximum returns from the insurance, will be around Rs. 27 lakhs if you stay invested in it and pay premiums regularly for 25 years.
What if I surrender this traditional plan and invest the premium in equity funds?
- Now let’s assume that you have paid premiums for 3 years and now want to surrender the policy. In this case, if you surrender, the entire Rs 1.5 lakh (3 years premium) gets lost (if the minimum premium paid years is 3 years). But wait. Now you have freed up Rs 50,000 per year for the next 22 years that you can invest elsewhere. If you invest Rs 50,000 yearly (or say Rs 4100 monthly) in a good Mutual Fund offering 12% for 22 years, then your mutual fund investment will be worth Rs 52 lakhs. So this investment will compensate for the loss of 3 years premium.
- In the second case, let’s say you discovered a little late, have been paying premiums for the last 5 years, and wish to cancel the insurance with just 20 years remaining in its term. If you give up in this situation, you will receive some surrender value back. Although the exact amount may vary, it would be around Rs. 50,000. You paid a total of Rs 2.50 lakh over five years, and you were given back Rs 50,000 as surrender value. Thus, when you give up, your total loss is Rs 2 lakh. However, you now have an additional Rs 50,000 to put in mutual funds each year for the next 20 years. The entire amount of money you have invested in mutual funds is around Rs. 40 lakhs, assuming 12% p.a.
From the above illustration, you can understand that the later you surrender the policy, the lower will be the benefits as the money will get lesser tenure to grow in mutual funds.
What Should You Do?
- In the initial period of your insurance policy, do not think too much. Just forget about losses and surrender the Insurance policy. You will save future premiums by surrendering the policy, which can be utilized effectively. Further, you can also invest the surrender value properly to recover some of the losses. Mutual Funds are one of the good options to invest in the long term.
- Another point of view is that, after a few years of premium payments, your yearly premium, as a percentage of your income, is significantly lower now than it was a few years ago. Thus, if you are already regularly investing a substantial amount in suitable assets such as debt (via FDs, NPS, EPF, VPF, PPF, mutual funds, and stocks) and equity (via stocks), then augmenting it slightly with the funds released from the sale of the insurance policy and the premium amount won’t amount to much.
- As a general rule, it is best to surrender the policy as soon as possible. However, you would be better off sticking with the plan until it matures, if you have an older policy, you have been paying premiums on time for a higher number of years, and if you are only a few years away from maturity or, let’s say, you have already finished half of the policy term. Since a significant portion of the policy’s term has already passed, you may choose to keep the insurance until it matures. A common trait among people is their inability to incur loss.
- The last choice, which could potentially be more appealing to more individuals, is to make the policy “Paid-Up” and discontinue making future premium payments. Then, you may invest with the (freed-up) future premiums to increase your mutual fund returns.
If you prefer not to invest in equities, you can also invest in debt securities. You can still earn higher returns from investments like PPF or VPF and other similar plans than from insurance.
But no matter what you decide to do, please remember to purchase adequate term life insurance for yourself.
Make this decision as quickly as possible if you don’t already have one.
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