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

Published: January 4, 2015 at 8:00 am

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:

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.

fork-in-the-road
Fork in the road, decision tree, September, Discovery Park, Seattle, Washington, USA. Photo Courtesy: Wonderlane

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.

Do share if you found this useful
Share your thoughts on this topic at the  Reddit freefincal_user_forum

Reach your financial goals like a pro! Join our 1600+ Facebook Group on Portfolio Management! You can now reduce fear, doubt and uncertainty while investing for your financial goals! Sign up for our lectures on goal-based portfolio management and join our exclusive Facebook Community. The 1st lecture is free!
Want to check if the market is overvalued or undervalued? Use our market valuation tool (will work with any index!) or you buy the new Tactical Buy/Sell timing tool!
About the Author Pattabiraman editor freefincalM. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. since Aug 2006. Connect with him via Twitter or Linkedin Pattabiraman has co-authored two print-books, You can be rich too with goal-based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management. He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice. He conducts free money management sessions for corporates and associations on the basis of money management. Previous engagements include World Bank, RBI, BHEL, Asian Paints, Cognizant, Madras Atomic Power Station, Honeywell, Tamil Nadu Investors Association. For speaking engagements write to pattu [at] freefincal [dot] com
About freefincal & its content policy Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on developments in mutual funds, stocks, investing, retirement and personal finance. We do so without conflict of interest and bias. Follow us on Google News Freefincal serves more than one million readers a year (2.5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified from credible and knowledgeable sources before publication. Freefincal does not publish any kind of paid articles, promotions or PR, satire or opinions without data. All opinions presented will only be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
Our publications

You Can Be Rich Too with Goal-Based Investing

You can be rich too with goal based investingPublished by CNBC TV18, this book is meant to help you ask the right questions, seek the right answers and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now. It is also available in Kindle format.
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want Gamechanger: Forget Start-ups, Join Corporate and Still Live the Rich Life you wantThis book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at low cost! Get it or gift it to a young earner

Your Ultimate Guide to Travel

Travel-Training-Kit-Cover-new 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 Rs 199 (instant download)
Free android apps