In India, buying a traditional life insurance policy is almost a family tradition. It is often the first thing people buy when they start a job. But recently, you might have heard a lot of noise from financial experts or friends. They keep saying, “Why are you keeping that old policy? Surrender (close) it immediately and put that money into Mutual Funds. You will get much better returns there!”.
About the author: Ajay Pruthi is a fee-only SEBI-registered investment advisor. He can be contacted via his website plnr.in. Ajay is part of the freefincal list of fee-only advisors and fee-only India.
It sounds like an exciting idea, right? But before you rush to the insurance office to close your policy, we need to ask a very important question:
Is this advice always true for everyone?
The answer is no.
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It is not a simple Yes or No. It depends on your specific situation. Let’s break this down into simple parts. Before moving ahead,
This is not a suggestion to surrender your policy, make it paid-up, or invest your money in other instruments. Please consult your financial adviser before making an informed decision.
Read this if you are planning to surrender a ULIP policy – How should I exit a ULIP purchased by mistake?
- The Story of Real Loss vs. Dream Profit
First, we must understand how money works when you stop a policy midway. When you surrender a traditional life insurance policy, the insurance company does not give you back all the money you gave them. They cut a large chunk of it as a penalty.
This loss is real. The money is gone from your pocket forever.
On the other hand, the profit you hope to make by investing that money elsewhere (such as in equity mutual funds/stock market) is notional. Notional is just a fancy word for imaginary or assumed. You are basically accepting a guaranteed loss today because you are assuming you will make a big profit in the future to cover that loss. But the future is never 100% sure.
Let’s look at a numerical example: Imagine you bought a policy and have paid ₹5 Lakhs in premiums so far. If you go to the insurance company today to surrender it, they might say, Okay, we will only give you back ₹3 Lakhs.
This means you have instantly lost ₹2 Lakhs. This is a real loss. Now, the people telling you to switch will say, Don’t worry! Take that ₹3 Lakhs, invest it in Mutual Funds, and it will grow to ₹10 Lakhs soon! That sounds great, but remember: you are starting the race ₹2 Lakhs behind. You have to earn a lot just to get back to where you started. The gains are just a dream right now, but the ₹2 Lakhs loss is a reality.
3. The Rishtedaar (Relative) Dilemma
In India, we rarely buy insurance from strangers. We buy it from a Chacha-ji (uncle), a neighbour, a close friend, or even our own parents or in-laws. This makes the decision emotional, not just financial.
If you stop the policy, your uncle might get upset. He might say, I sold you this for your own good, and now you are stopping it? This can make family gatherings awkward.
So, how do you choose between money and relationships? You need to look at the impact on your wallet:
- Scenario A: The Small Token. Let’s say your monthly salary is ₹1 Lakh, and the policy premium is just ₹5,000 per year. This amount is very small compared to your income. In this case, it might be better to just keep paying the premium. You prioritize the relationship because the financial cost is low. You keep the uncle happy, and it doesn’t hurt your wallet.
- Scenario B: The Heavy Burden. Now, imagine the premium is ₹2 Lakh per year, and you are struggling to pay your child’s school fees. In this case, your financial wellness must be your priority. You cannot suffer financially just to keep a relative happy. If the premium is really high and hurting your life, you should choose your financial well-being over the relationship.
3.The Race Against Time Think of your insurance policy like a long marathon race. To decide if you should quit the race, you need to check the Premium Payment Term (how many years you have to pay) and the Policy Term (how long the policy lasts).
Case 1: The Race is Almost Over Let’s say you have a policy where you need to pay premiums for 15 years. You check your records and see that you have already paid for 8 years. You are more than halfway there! In this situation, it is usually better to continue the policy. Why? Because you have already paid the high costs in the beginning. If you quit now, the time left to invest elsewhere and recover your losses is very less. You might not catch up.
Case 2: The Race Has Just Begun Imagine a different policy that lasts for 35 years, and you have paid for 12 years. Even though 15 years sounds like a lot, you still have 23 years left to go! That is a very long time. In this specific situation, you still have a chance to recover your losses. If you take your money out now and invest it in high-growth options (like equity mutual funds), you have 22 years for that money to grow. This long time frame gives you a better chance to beat the losses.
Important Warning: Only choose this option if you have a high-risk appetite. This means you are brave enough to see your money go up and down in the stock market without getting scared.
4. Are You Getting Toffee or Gold? You need to check what kind of reward (return) your policy is giving you. Many traditional policies, like Money Back policies, give very low returns—often around 3% to 4%.
If you calculate that your policy is only growing by 4% each year, while prices in the market (like milk, bread, and petrol) are rising by 6% each year, you are actually losing value. In this case, it is better to surrender. Don’t assume your policy is giving you 5-6% or more. Not all policies are that generous. You must do the math.
5. The Helmet Rule: Safety First!
This is the most critical rule of all. If you decide, Okay, I will surrender my old policy, do not do it immediately! You must buy a Term Insurance policy first.
Term insurance is like a pure safety helmet. It gives your family a lot of money if something happens to you, but it costs very little.
Why buy it first? Imagine you surrender your old traditional policy today. Tomorrow, you will apply for a new Term Insurance policy. The new insurance company checks your health and says, Sorry, you have high blood sugar, we cannot give you insurance. Now, you are in big trouble. You have lost the old cover, and you cannot get a new one. You have left your family completely unprotected from both sides.
Example: Always get the new policy letter in your hand before you stop paying for the old one.
6. What If I Don’t Want to Quit?
Maybe you don’t want to surrender. You have other options:
- Align with Goals: Instead of thinking of it as a bad investment, label it. Say, This policy money will be used for my daughter’s college admission or This is my retirement bonus. Treat it as the safe part of your savings (Debt investment).
- Make it Paid-Up: This is a great middle path. You stop paying the premiums, but you don’t close the account. The company keeps your money, and the insurance coverage reduces, but you don’t lose everything. The policy continues until the end, just with a smaller payout.
Try to avoid taking a loan against your policy. It is usually not a good option because the interest rates can be higher than the returns in the policy.
Disclaimer– Nothing in the article is a solicitation, recommendation, endorsement, or offer by the author or the editor. If you have any doubts as to the merits of the article, you should seek advice from an independent financial advisor. *Registration granted by SEBI, BASL membership, and NISM certification does not guarantee the intermediary’s performance or provide any assurance of returns to investors. Investment in the securities market is subject to market risks. Read all the related documents carefully before investing
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