Should you surrender or pay up your LIC?
If you are here, it’s because you’ve probably had a poor experience with a life insurance policy. Perhaps you were sold a low return policy without a proper explanation of product features, or you just bought life insurance to save taxes at the year end… and now you are wondering whether you should surrender your policy. Don’t worry, you are not alone! Every year, thousands of insurance policy buyers go through this dilemma of being ‘trapped’ in a product that does not add any long-term value to their finances. Our experts are here to help!
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Did you know – 2/3rd of life insurance policies do not get renewed beyond their 5th year?
Only 1 in 3 policies in India go on to get renewed in their fifth year, and this is a huge problem for investors as they end up losing a lot of money in these policies. There are many reasons behind this phenomenon of dismally low “persistency” number. Some attribute it to the mis-selling by agents, many of whom are highly commission focused and not really concerned about what’s right for their clients. Some say this is due to increasing awareness about Mutual Fund SIP’s through AMFI’s Mutual Funds Sahi Hai campaign, leading to more investors wanting to stop paying premiums and starting SIP’s instead. Others, still, believe that this is due to the rising popularity of the concept of ‘pure risk’ products – which is leading to investors stopping paying their premiums for their traditional plans.
Whatever the reason may be; if you have chosen to stop paying the premiums for LIC policy after paying for at least three years (or two years for a policy with a term of less than ten years), you’ve basically got three choices: make the policy paid up, continue paying till the end, or surrender it. Which one makes more sense?
Surrender vs Paid up – the basic difference
First up – what’s the difference between surrender vs paid up? Let’s explain. From the third year onwards, your policy begins to acquire what is called a “surrender value”. Before that, surrender of policy will give mean writing off the investment altogether. At this stage, you may choose to stop paying further premiums at this stage and surrender your policy. If you do so, you receive a fraction of the premiums you’ve paid, and the death benefit associated with the policy ceases, of course. In fact, the surrender value is as low as 30% in the 4th year for most LIC policies, making an exit prohibitively costly!
When you make a policy paid up, the requirement for paying future premiums ceases too. However, you receive no encashment value or “surrender” value. Future ‘annual bonuses’ stop accruing within the policy, and your policy’s sum assured gets adjusted on a pro rata basis depending upon the total number of premiums paid, divided by the total premiums due. For instance, if you’ve got a 10-year traditional plan with a sum assured value of Rs. 10 lakhs, and paid 5 premiums before making it paid up, the sum assured figure gets adjusted to Rs. 5 lakhs (10 * 0.5)
When paid-up makes sense…
Making your LIC policy “paid up” makes sense for two reasons. First, the costs of surrendering your policy, especially early on, can be prohibitive. For a 10-year, 10 lakh basic sum assured policy that has completed 4 premium paying years, the surrender value for most traditional plans will likely be 30% or so; implying that you’ll receive just about Rs. 1.33 lakhs for the Rs. 4 lakhs you’ve shelled out. Even if you were to grow this money at a reasonable 12% rate of return for the remaining six years, you’d end up with a corpus of just Rs. 2.62 lakhs. Clearly, you’re better off keeping the policy in force as ‘paid up’ and receiving Rs 4 lakhs, plus accumulated bonuses over the 4 premium paying years, plus a possible guaranteed loyalty bonus (varies from LIC policy to policy).
Secondly, surrendering the policy means letting go of the associated death benefit – this may not be sensible for those who are in their late thirties or forties, as it becomes increasingly difficult to get new policies issued without underwriting related hassles. The body does go through it’s inevitable wear and tear, increasing risks for insurers in the process!
Surrendering a policy also leads to the “pain” of writing off money, as doing so would most likely involve booking a huge loss of 30% to 70% of premiums paid, depending upon the type and stage of your policy (refer your policy’s benefit illustration for the precise surrender value associated with it). By making your policy paid up, you circumvent this pain as well.
When surrendering makes sense…
There may be scenarios when surrendering makes financial sense – that would be when your policy is a long term one (say 25 years) and you have just started off with it a few years ago, meaning that you still have 20-23 years premium paying years left. In such a scenario, you could potentially end up creating more wealth by surrendering the policy and investing it smartly for the pending decade-plus time horizon. Your age also needs to be taken into consideration from the perspective of how easy or difficult it would be to replenish the lost cover through a term plan.
Your choice is a tough one, no doubt. You can either surrender your policy and write off 1/3rd of your money – or you can make it paid up and receive the adjusted sum insured 20 years later. However, remember that inflation will greatly erode the purchasing power of that money over 20 years. Receiving Rs. 5 lakhs after 20 years is equivalent to receiving Rs. 1.55 Lakhs today (when you adjust for 6% inflation), so you would be better off surrendering it and reinvesting Rs. 1.5 Lakhs in a growth asset for 20 years. Even at a modest 10% return, this 1.55 Lakhs would grow to Rs. 10 Lakhs!
There are some scenarios when you should continue paying till the end as well!
In fact, if you’re just 2-3 years away from the maturity of your LIC policy, you should probably just pay off the rest of the premiums and not compromise on the maturity amount! A qualified Financial Planner could help you with your decision.
End Note: in most scenarios, it’s sensible to make your traditional policy ‘paid up’ instead of surrendering the policy altogether. If any (or all) of these apply to you, you may need to consider surrendering the policy, though: One, you’re in your twenties right now. Two, your policy has acquired a surrender value exceeding 60% of your premiums paid. Three, you’ve got quite a few years (at least seven) remaining until your policy’s maturity date.
Every policy is different – consult with an expert to understand the best course of action for your specific policy
FAQs – Surrendering your LIC Policy
I am worried about losing 40-50% of my money while surrendering my policy. What should I do?
This is completely normal. Nobody likes to write off large sums of their hard-earned money. However, if you have many years left for your goal, it makes sense to take the hit and reinvest the money aggressively. Not doing so will mean throwing good money after bad as you will need to keep paying premiums to keep the policy in force. If you’ve already paid 70-80% of your premiums though, you don’t need to surrender the policy, you can just continue paying until the end and receive your maturity proceeds.
What should I do with my surrender proceeds?
You should ideally reinvest your surrender proceeds in sync with your financial goals. For example – let’s say that you paid Rs. 3 Lakhs for a 20 year LIC policy and surrendered after 3 premiums, receiving Just Rs. 1 Lakh. Since you have a time horizon of 17 years, you can invest this Rs. 1 Lakh aggressively in high growth mutual funds that can fetch you between 12-15% CAGR if you invest with discipline and resilience. At a 13% CAGR, this 1 Lakh can grow to around 8 lakhs in this time frame.
Should I start a SIP with the saved premium amount after surrendering my policy?
Yes. You should ideally work with an investing expert to map out your long and short term goals, and then start a SIP accordingly. Over the long term, a SIP can help you create a lot more wealth than a traditional insurance policy, which is structurally incapable of delivering inflation beating returns.