Righting a Wrong Turn on Life Insurance Policies

Gullible people at large, often buy aggressively wrong unit-linked insurance plans, pension plans or traditional plans like endowment, money-back and whole-life policies as means of saving regularly and realize a few years later they have been bought a lemon that have been converted into the peanuts. To get out from these poor investments, some may suggest that you turn your policy make either into a ‘paid-up’ or surrender the policy, one without even explaining its implications means that have to pay a heavy price to switch out, which is compounded by another wrong decision. After all, it’s your hard-earned money, you should think hard before tempting to do anything on the ground that something else appears to be more attractive such as equity, real estate or gold etc. Though, it has no easy solution to get rid from these trapped insurance policies, this article endeavors to provide optimal solutions so that the loss could be minimal.

Old Traditional Product ‘Paid up’ or Surrender

It is very much true that any traditional endowment policy from any insurance company including LIC has neither been giving more than 7% to 8% returns on your investment even in the long-run, say 16 years, nor giving any adequate cover to meet one’s financial protection requirement after one’s demise. To continue or not to continue the policy, this catch-22 situation is bagging a genuine need to understand the best way out for all traditional products along with an understanding of any adverse tax implications on them. If you have to exit, you get peanuts as surrender value and hence, your new investments would also get an opportunity to invest in high return products that compensate for the loss you incurred on surrendering the policy. But, it may not be generic advice of surrendering would definitely benefit on your existing investment. It will depend on the insurers, what they will offer the guaranteed surrender value (GSV) on your particular insurance policy. Moreover, you have to also find out what the special surrender value (SSV) really amounts to in your policy. This may depend on how many years your policy has been paid premiums, the policy term, the product, the company performance and so on.

For beginners, if you are unhappy with your existing traditional insurance product and intending to surrender the policy within three years of a policy, you should know that you would get just 30% of the premium paid minus first year premium plus partial bonus. So, while hoping to make it up with big gain in a new investment does not make sense early in the term. It may better to continue the policy until to make eligible to convert your policy into ‘paid up’ one, if you have strong reasons to believe that the originally purchase product is a mismatched for you and does not fit into your any financial goal. In paid-up option your existing premiums would remain invested after paying minimum three premiums and not to be paid any future premiums. But in that case, your sum-assured would effectively reduced in the same ratio to the full SA as the number of premiums actually paid bear to the total number of premiums originally payable in defined term of the policy. Hence, this paid-up value along with vested reversionary bonuses, if any would be payable to the policyholder at the end of the policy term or on death, whichever is earlier. Now, the question crops up, is it viable option to turn your policy paid up or not? Let’s explore on this with following example:

Example: Suppose, you have aged at 25 and bought LIC endowment plan with a policy term of 10 years and are paying a premium of Rs 51,516 for sum assured of Rs 5 lakh. If you get convert your policy to paid-up after paying five premiums, it means you would have paid Rs 2,57,580. In that case, your paid-up value will be made half of your sum assured, which is Rs 2.50 lakh and will be paid on death or end of the policy term along with bonus declared while assuming total bonus based on current bonus rate of Rs34 per thousand of SA (which is the most likely in all LIC policies) is Rs 85,000 i.e. Rs 3.35 lakh which reflects the return on your premium paid at the end of 10 years is just paltry percentage at 3.33%. On the other side, if you continue premium payment till the end of policy term, the return on premium would have been 4.73%. Hence, it is evident that ‘Paid-up’ policy may not be the best solution, but better than policy surrender which will amount to financial hara-kiri.

Disclaimer: This is not a professional advice as it is used as an illustrative purpose only. Before plunge, you should consult your financial planner who could be able to assess your real value of insurance paid-up value. It is a very hard-core decision to surrender or continue the policy.

What to do with Old and New ULIPs

As of now, you have been holding an old ULIP i.e. bought before September 2010, you had paid hefty charges in front loading i.e. big chunk of the first three premiums were eaten up by that damned charges. If you stuck into this idiotic product and unable to pay the future premiums, you would have to find a suitable time when the surrender charges are minimal or zero. While assuming negligible or no surrender charges, you should to make an exit, even, if the fund value is below par and buy mutual funds with good track record for your investment and go for a decent cover term plan to ensure continuous life insurance cover. Old ULIP holders can also use a great ‘cover continuance’ feature in which you could stop paying after three premiums and continue with the policy and your funds would remain invested in your choice of fund option. The morality charges and other fund management charges will be deducted to maintain the insurance component by cancelling the units held by you. It must be noted here that using ‘cover continuance’ feature does not mean you are a long-term, disciplined investors interested in rupee-cost averaging of your investment.

But the new ULIPs don’t offer this feature due to mis-selling by intermediaries. In the new ULIPs, there are no surrender charges after five years. Premium discontinuance after completion of the fifth year will give policyholder the option to revive a policy within the eligible period of one month or so otherwise, you will get the full fund value. If you still want to surrender new ULIP before the lock-in period of five years, you have to pay surrender charges which will depend on the year of surrender as well as premium amount. For example, if you surrender after paying only one premium, the maximum surrender charges as per IRDA will be Rs    3,000 for premium up to Rs 25,000 or Rs6,000 for premium above Rs 25,000. Moreover, the surrendered amount will be returned only after completion of five years of policy, but you will get 4% p.a. interest.

The nightmare Old and New Pension Plans

Old pension plans are those which were sold before December 2012. While surrendering the a pension product anytime before maturity, needless to say you have to take a hit on the surrender charges and worse that you will have also to give back the 80C tax deduction that you had claimed. In the worst scenario, your surrender value has also to be added to your income without deducting the premium paid and to be taxed as per your slab in the year of surrender. If you continue the policy, you would get a one-third of the corpus as tax-free commuted value and the remaining can be invested in an annuity product sold by the insurance company. And, the annuity product will generate interest income every year, which would also be taxable in policyholder’s hand. Hence, it‘s nightmare for anyone who has bought any pension plan and surrendered on later.

Do share your loving comments, what should make the right choice before buying life insurance?

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