Random Advice On Policy Surrender And Its Impact

I had purchased 2 endowment policies during the last year. Presently, I am paying a premium of 2 Lakhs per annum for these 2 policies. I have heard that insurance policies are not good for investment since the returns in these policies are quite low. So, is it advisable to opt for policy surrender in the above-stated case?

There’re normally 2 types of suggestions you’ll receive from different people whether it’s advisable to surrender a policy or not.

1. The ones who’re a bit financially literate and against insurance policies would immediately say yes. Their first comment would be – surrender the policy and invest in mutual funds instead.
2. The second ones would be those who’ll show you all the benefits of the policy like the sum assured, accidental benefits etc. Such people would advise you against surrendering the policy.

Now, both the above-mentioned suggestions are nothing more than random advices on policy surrender. In fact, they will cause more harm than any benefits. Let me explain how it works.

Let us modify this query. I had purchased 2 endowment policies during the last year. As of now, I am paying a premium of 2 Lakhs per annum for these 2 policies. The term of both policies is 10 years. So, is it advisable to surrender the policy in this case?

Even in such a scenario, there would be people who’ll still advise you to surrender the policy.

But, should you follow their advice?

Also Read: Taxation on Surrender of ULIP

Policy Surrender – How To Decide?

Returns

Suppose you surrender these policies after a period of 1 year. Here, you won’t get anything as endowment policies do not carry any surrender value after a period of 1 year. Therefore, you will have to face a major monetary loss of 2 Lakhs. Now the most important question is – Can you recover these losses in the next 9 years?

Suppose, you’ve just dropped the policies and invested the future premium of 2 Lakhs per annum in debt mutual funds. And, the returns that you’re getting from this investment are 7%. What will you get after a period of 9 years?

Invested Amount – 18 Lakhs (As only 9 years would be left after you drop the policy.)

Value after 9 years @ 7% returns – 24 Lakhs

Now if I were to assume 5% returns in those 2 endowment policies:

Invested Amount – 20 Lakhs

Value after 10 years @ 5% returns – 25.2 Lakhs

The maturity value would be tax-free although you would have to pay some tax on debt funds. Liquidity is definitely better in debt funds but why to take a loss when you can easily avoid it.

What if I want to invest the future premiums in equity mutual funds? Would I not recover my losses and have some gains too?

Risk Profile

This is the most important question; investors should ask themselves. What is your risk profile? What sort of an investor are you – Conservative, Balanced or Aggressive?

Just because everyone is saying that equity mutual fund returns are better, do you need to invest in mutual funds? Would you be able to deal with the market volatility and keep your money invested?

Let us assume that you are a balanced investor. And you’re willing to invest 2 Lakhs per annum in equity/debt mutual funds in the ratio of 50:50.

What will you get after a period of 9 years?

Invested Amount – 18 Lakhs

Value after 9 years @ 9% returns – 26 Lakhs

Now if I were to assume 5% returns in those 2 endowment policies:

Invested Amount – 20 Lakhs

Value after 10 years @ 5% returns – 25.2 Lakhs

For a meagre difference of 80,000, you’ll end up taking all the big risks associated with financial markets. And not to forget the headache to rebalancing afterwards.

And what if there is any goal associated with this amount after a period of 10 years? Would you still like to take a risk in the financial markets for an additional amount of 80,000?

If these returns in mutual funds drop down to 8%, the amount value after 9 years would be 25 Lakhs.

Still not advisable to surrender the policy, Right!

Term Of Policy

Suppose we increase the policy term to 15 years in the above-mentioned example. Would it make sense to surrender the policy in such a case?

For a conservative investor, it still does not make any sense at all. As the policy term increases, the returns in most endowment policies also rise a bit.

So, assuming a 5.5% return in endowment policy and 7% in debt mutual funds. The amount received in both cases would be the same. (i.e. around 45 Lakhs)

Whereas if you are a balanced investor and assume 9% returns in mutual funds, then it does make sense. It is so because mutual funds will give you 52 Lakhs at the end of 15 years (assuming 9% returns). On the other hand, the endowment policy will give you 45 Lakhs within the same tenure.

If the returns are 10% in mutual funds for a duration of 14 years, you’ll get around 56 Lakhs.

Taxation

What about taxation, would the amount be taxable? Since you would not be getting any surrender value, there is no question of taxation in this case. But if you had claimed any tax benefits for the total premium paid, the tax benefits would have been reversed. The premium would have got added to your income and taxed accordingly.

What About ULIPs?

ULIP is a big issue if you surrender the policy within the first 5 years. First, all your tax benefits under Section 80C will get reversed if you have claimed for the previous years.

The money receivable (after 5 years) would be added to your income and taxed as per your slab. For this reason, it’s better to calculate your tax liabilities before surrendering a ULIP within the first 5 years.

Till then, Happy Investing!