We often find investors taking an insurance policy at the end of the financial year just to save more tax. The result: Of course you do save some tax, however, you may also end up with a policy that you actually may not need. But this does not mean you need to be stuck with the policy through its entire course. Almost all insurance policies (with the exception of a term plan) have some sort of exit option that could be exercised, although they come at a cost. So when and how do you exit such life insurance policies that you don’t need anymore?
Exiting in the initial phase of the policy
• The Free look period
The earliest exit option provided by insurance companies (and mandated by IRDA) is the free look period. The free look period entitles every policy holder 15-days from the receipt of the policy to rethink over the purchase. So in case you feel you have been mis-sold, or are not happy with the policy you could return it to the insurance company and request for a premium return. The insurance company returns the premium amount after deducting charges towards medical tests, stamp duty and service charges. These charges would not be refunded.
• Letting the policy lapse
If you have missed the free look period, the easiest way to exit a policy during the initial years is to let the policy lapse. In fact, there is no other way, but to let the policy lapse, as insurance companies do not provide any exit option in the first three policy years. Stop paying your premiums and your policy lapses. Do remember, you would not receive anything if the policy lapses and all your premiums would be lost.
Term plans do not have any exit option beyond the free look period. Hence it is best to let it lapse.
Exiting after three years
Insurance companies offer the following exit options after the policy has completed three policy years.
• Surrendering the policy
Policy surrender is a voluntary termination of the insurance policy, before its maturity. When you surrender an insurance policy, the insurer pays you a lump sum amount known as the cash value or surrender value.
From the regular premiums that you pay, a part goes towards investments and the remaining goes towards the life cover. This invested portion accumulates as the cash value during the course of the policy, and is paid out on surrender of the policy (net of all charges). Cash value accumulates as long as the policy exists. In the early years of the policy, this value remains pretty low. It increases as the policy moves closer to maturity. Insurance companies offer a guaranteed surrender value of around 30% of the total premiums paid subsequent to the first year.
• Letting the policy become paid up
Instead of completely exiting a policy, you could also opt to make your traditional endowment plans paid up. In a paid-up policy, you could discontinue paying your premiums. The policy does not go void but continues at a reduced sum assured. This reduced sum assured is known as the paid-up value. All additional benefits, future bonuses and dividends attached to the policy would be lost in such a policy. Any bonuses accrued in the first three years however would be paid on maturity.
For example: Suppose you have an insurance policy with a sum assured of Rs. 10,00,000 for 10 years and you have already completed paying premiums for the first 3 years. The paid up value would be calculated as below.
• Timing the market
If you are exiting your unit linked plan, your units would be redeemed at the prevailing NAV on the date of redemption. Check to see the market sentiments and behavior before exiting. Giving up a market linked plan, when the markets are low is not advisable
When you should hold on to the policy
Insurance policies especially unit linked plans, prove to be more rewarding as the years pass on, as by then insurers would have already recovered the expenses on the policy. As the policy matures, the benefits in store are huge. So if you are towards the maturity of your policy with around 3-5 years remaining, it is wise to hold on.
If you plan to exit an insurance policy and wish to reinvest the proceeds in an alternative investment, make sure your new option would not only earn you superior returns but also has the potential to recover the losses that you have incurred in exiting the insurance policy.
Also, do not exit a life insurance policy, if you do not have any other life insurance. Your life should be covered at all times.