To Surrender, or To Make Paid-up, that is the question!

Thanks mainly to personal finance bloggers, more and more individuals are recognising to the need to treat inflation as the benchmark for long-term goals. With this comes the inevitable realisation that investments that have an insurance component in them – endowment plans, money-back plans, traditional with-profit plans and market-linked ULIPs etc. are unlikely to help them achieve their goals.

This is because the poor return offered by these policies – (5-7% tax-free) for traditional plans – implies for a person to meet long-term goals, the premium will have to much, much higher than what they can afford.  This is the only way to beat inflation with such products.

Since most people cannot afford high premiums, the only other option to beat inflation is to invest the amount in assets that can result in a return higher than inflation after taxes. The natural choice is equity.

However, before the person can begin equity investments, the question of what to do with existing ‘junk’ policies must be answered.

I have taken up this issue from a logical standpoint earlier:

• OMG! Just Realized My Insurance Policies are Worthless! What do I do?
• Insurance Policy Surrender Value & Paid-up Value Calculator

In this post, I would like to offer a simpler thumb-rule approach to this issue while not diluting the associated logic.

Step 1: Do I have enough life insurance? If yes, proceed to step 2. If not, find out how much insurance you need,

• with this tool, if you have dependents other than children: Insurance Calculator for the Young 
• and with this tool if you have children, comprehensive child planner
• The above exercise with take no more than 30 mins.
• You can declare your existing policies to the insurer and tell them that you intend to get rid of these once the term plan is issued.

Step 2:  Say this to yourself: I decide to stop paying any more premiums for worthless products.  I decide invest this sum productively as soon as possible, preferably from the current month.

This is the key step. Once you have decided to accomplish this, it does not matter whether you make the policy paid-up or surrender it. The exit option is irrelevant. The key is to head for the exit.

Making a policy paid-up implies, premiums stops but the relationship with the insurer continues with lesser insurance cover. At the end of the policy duration, the money due to you at the time of making the policy paid-up will be given to you. So the insurer retains the money (investing it to their benefit) and give it to you after (several) years.

Surrendering a policy implies all ties with insurer are immediately severed. The insurer pays a surrender value (much lower tha paid-up value) but pays it immediately.

Step 3:

(a) Some people ask,

“I have paid only one premium and have two more years to exit the policy. What do I do?”

Answer:  It is only money. Let it go. Stop paying further premiums.

or

“I have paid two premiums and have one more year to exit the policy. What do I do?”

Answer: You pay one more premium which you will lose anyway when you exit! Makes no sense. It is only money. Let it go. Stop further payment.

(b) If you have less than 5Y left in the policy period, best not to exit. Future premiums when invested elsewhere should be able to get about 7% after taxes. This may not be possible for those in 20% and 10% tax slabs.  Why take the chance?

(c) If you have 5Y-10Y left in the policy period, you can exit the policy and invest future premiums in a portfolio with limited equity exposure. Examples are debt oriented balanced funds (MIPs) or even equity-oriented balanced funds if you can understand and stomach the risk (not an easy task for those used to fixed-income products).

In such cases, should one surrender or make the policy pre-paid?

It is not about money. Not about in which option one would lose more or gain more.  It is psychology!

Paid-up offers some emotional benefits.  The perceived loss is lower. There is some insurer cover and it makes the insurer do some work for the worthless product that you have got from them.  The time value of money (paid-up amount sleeps with the insurer from investors point of view)  should be taken into account, but we are not applying logic here.

Surrendering offers different emotional benefits. You have cleared the slate: good riddance to bad rubbish*. You can now invest the surrender amount productively along with future premiums.

• rubbish here is not the product or the agent who sold you the product, but your own lazy, uninformed avatar.

The question is not which option is better from a monetary point of view. The question is which option is better from an emotional viewpoint. Which would make you happy? Choose that option. Simple as that.

(d) If you have more than 10Y left in the policy period, exiting via surrender is the obvious choice. This is because both the surrender value and future premiums can be invested in productive assets.

Want to conduct a sales-free "basics of money management" session in your office?

I conduct free seminars to employees or societies. Only the very basics and getting-started steps are discussed (no scary math):For example: How to define financial goals, how to save tax with a clear goal in mind; How to use a credit card for maximum benefit; When to buy a house; How to start investing; where to invest; how to invest for and after retirement etc. depending on the audience. If you are interested, you can contact me: freefincal [at] Gmail [dot] com. I can do the talk via conferencing software, so there is no cost for your company. If you want me to travel, you need to cover my airfare (I live in Chennai)

---

Connect with us on social media

• Twitter @freefincal
• Facebook
• Subscribe to our Youtube Videos
• Posts feed via: Feedburner
• We are also on Google PlusandPinterest

---

Do check out my books

---

You Can Be Rich Too with Goal-Based Investing

My first book is now available at a 35% discount for Rs. 258. It comes with nine online calculators. Get it now.  The Kindle edition is only Rs. 199.

---

Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want

My second book is now only Rs 199 (Kindle Rs. 99) Get it or gift it to a youngearner

---

The ultimate guide to travel by Pranav Surya

This is a deep dive analysis into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, how travelling slowly is better financially and psychologically with links to the web pages and hand-holding at every step.  Get the pdf for ₹199 (instant download)

---

Create a "from start to finish" financial plan with this free robo advisory software template

---

Free Apps for your Android Phone

All calculators from our book, “You can be Rich Too” are now available on Google Play!

---

Install Financial Freedom App! (Google Play Store)

---

Install Freefincal Retirement Planner App! (Google Play Store)

---

Find out if you have enough to say "FU" to your employer (Google Play Store)

---

About Freefincal

Freefincal has open-source, comprehensive Excel spreadsheets, tools, analysis and unbiased, conflict of interest-free commentary on different aspects of personal finance and investing. If you find the content useful, please consider supporting us by (1) sharing our articles and (2) disabling ad-blockers for our site if you are using one. We do not accept sponsored posts, links or guest posts request from content writers and agencies.

Blog Comment Policy

Your thoughts are vital to the health of this blog and are the driving force behind the analysis and calculators that you see here. We welcome criticism and differing opinions. I will do my very best to respond to all comments asap. Please do not include hyperlinks or email ids in the comment body. Such comments will be moderated and I reserve the right to delete the entire comment or remove the links before approving them.