Life insurance involves a contractual agreement between an individual and an insurance company. The individual pays a premium to the company. In exchange, the company commits to paying a lump sum amount, referred to as the death benefit, to designated beneficiaries (such as a spouse, children, or parents) in the event of the individual’s demise.
This death benefit offers financial security to the beneficiaries, assisting them in managing the impact of the loss of income and support resulting from the individual’s death.
Surrendering a policy means terminating the contract with the insurance company and giving up the rights to the death benefit and the cash value. When you surrender a policy, you receive a lump sum (the surrender value) from the company.
The surrender value is usually less than the cash value because the company deducts some fees from it. Surrendering a policy is a permanent and irreversible decision, so you should be careful before doing so.
Why is surrendering a policy, not a good idea?
Here are some of the main reasons why you should avoid surrendering your term insurance policy:
1. Loss of coverage
When you surrender a policy, you lose the death benefit that can offer monetary security to your beneficiaries in case of your death. The death term insurance benefit can aid in covering funeral costs, outstanding debts, and daily living expenses.
For example, if you have a policy with a death benefit of Rs 50 lakhs and you die, your beneficiaries will receive Rs 50 lakhs from the insurance company. But suppose you surrender the policy and receive a surrender value of Rs. 10 lakhs. In that case, your beneficiaries will get nothing from the insurance company and will have to manage with Rs. 10 lakhs only. This can put them in a difficult situation, especially if they depend on your income and support.
2. Loss of benefits
When you surrender a policy, you lose the accumulated cash value that can be used for various purposes, such as investing, saving, or borrowing. The cash value can help you achieve your financial goals, such as buying a house or funding a child’s education.
For example, if you have a policy with a cash value of Rs. 15 lakhs and you want to buy a house worth Rs. 40 lakhs, you can use the cash value as a down payment and take a loan for the remaining amount. But if you surrender the policy and receive a surrender value of Rs. 10 lakhs, you will have less money to use as a down payment and have to take a bigger loan. This can increase your interest cost and reduce your savings.
3. Tax implications
When you surrender a policy, you may have to pay taxes on the gain from the surrender value and the surrender fees. The gain from the surrender value is the difference between the surrender value and the total premiums paid. The surrender fees are the charges deducted by the company from the cash value.
For example, if you have a policy with a cash value of Rs. 15 lakhs and a surrender value of Rs. 10 lakhs, and you have paid Rs. 8 lakhs in total premiums, you will have a gain of Rs. 2 lakhs (Rs. 10 lakhs – Rs. 8 lakhs) and a surrender fee of Rs. 5 lakhs (Rs. 15 lakhs – Rs. 10 lakhs). You will have to pay income tax on the gain of Rs. 2 lakhs, and you cannot claim any deduction for the surrender fee of Rs. 5 lakhs. This can reduce the net amount you receive from surrendering your policy and increase your tax burden. You should consult a tax advisor before surrendering your policy, especially if your policy has a high cash value and a low surrender value.
What are the alternative options?
Surrendering a policy is not the only option available. Here are some alternatives.
- Reducing the coverage: If you are finding it difficult to pay the premiums, you can reduce your policy coverage and pay a lower premium. This way, you can still keep your policy active and retain some of the death benefit and the cash value.
- Taking a loan against the policy: If you need some cash urgently and do not want to surrender or sell your policy, you can take a loan against the policy from the insurance company or a bank. This way, you can borrow a percentage of your policy’s cash value and pay a low-interest rate. You can repay the loan at any time or let it be deducted from the death benefit or the cash value when you die or surrender the policy.
Surrendering a life insurance policy is not a good idea because it has many disadvantages and drawbacks. You can lose your policy’s coverage, benefits, and tax advantages. You can also miss out on the alternative options that may be more beneficial for you. Therefore, you should think twice before surrendering your policy and seek professional advice. Life insurance is a valuable asset that can protect your family and your future. You should not give it up easily and regret it later.