Explained: Is surrendering your moneyback policy a wise idea?

• Surrendering a money-back policy within the first three years, often considered the lock-in period, is financially unwise.
  
• A moneyback policy will not beat inflation in the long run.
  
• In the last five years, it makes financial sense to exercise patience and allow the policy to reach maturity.
  

Meet Ms. Sharma, a working professional who, a decade ago, invested in a money-back policy. The policy had a sum assured of ₹10 lakhs, and she opted for a term of 20 years. Money-back policies, as the name suggests, are designed to return a portion of the sum assured at regular intervals during the policy term, ultimately delivering the full sum assured upon maturity.

Recently, she realised that her insurance coverage was not enough and got a term plan which takes care of her life insurance needs. She pays a premium of ₹38,000 on the policy and wants to know whether it makes sense for her to surrender her policy and invest the premiums elsewhere.

The surrender value of a money-back policy

The surrender value of a money-back policy is the amount you'll receive if you choose to terminate the policy before its maturity date. It's calculated based on factors such as the total premiums paid, policy duration, terms and conditions, surrender charges, and any accumulated bonuses.

Typically, the surrender value is less than the total premiums paid, especially in the policy's early years, due to the deduction of charges and expenses. Understanding the surrender value is crucial for policyholders considering surrendering their money-back policy and evaluating their financial options.

Surrendering the policy within the first three years

Surrendering a money-back policy within the first three years, often considered the lock-in period, is financially unwise. During this initial phase, the surrender value is minimal, and policyholders will face significant losses.

Surrender charges and deductions further reduce the amount received. It's typically more sensible to consider surrendering the policy after the lock-in period has passed.

“Moneyback life insurance policy hands over a large chunk of collected premium towards agent commission hence the option of surrendering the policy in initial years is not available,” says Abhishek Kumar, SEBI Registered Investment Adviser and Founder, SahajMoney.com.

How surrender value works for an endowment policy

Let us consider an example to understand the situation better. For the sake of calculation, let us say the entry age is 35 years and the policy is for a period of 20 years. The assured sum in this is ₹ 1,000,000 and the annual premium for the policyholder is ₹ 38,020 per annum.




*A typical moneyback policy has been considered in the above example

Surrendering the policy after three years

It may make sense to surrender an endowment policy after three years. “When the policy is made available to surrender, say after 3 years of premium payment then the surrender value usually starts around 30% of premium paid till then,” says Kumar.

In the above example, if you hold the policy till maturity an even if you consider a non-guaranteed return (bonus) of 10% which is on the higher side, the final payout after the guaranteed and non-guaranteed payouts will be around ₹8.97 lakh at a XIRR of 3.36%.

XIRR, short for Extended Internal Rate of Return, is a financial tool for determining the annualised rate of return on investments involving irregular cash flows.

Investing annual saved premium (₹38,020) and surrender value (₹34,218) after 3 years into fixed deposits will give returns of 6% (4% post-tax return). In case you invest the money in mutual funds, the returns will be potentially higher.

“The XIRR on such policy comes to less than 4% so effectively one is better off by investing the saved premium and surrender amount in a bank fixed deposit at 6% interest rate (4% post-tax return). They can buy a term plan for insurance for a much cheaper premium than a moneyback policy,” says Kumar.

Essentially, money back or any other traditional policy will not beat inflation in the long run so it's not a bad idea to surrender the money-back policy in the initial days of the policy after the lock-in period.

“You will be able to invest surrender value and future commitments in better available products but when investors see that they are going to lose a huge portion of the money they have invested (normally more than 50%) - they are not able to take any decision,” says Hemant Beniwal, principal financial planner, Ark Financial Planners.

Surrendering the policy in the last five years

Surrendering a money-back policy in the final five years of its term is often financially disadvantageous. By this point, the policyholder has already contributed a substantial portion of the premiums.

It makes more financial sense to exercise patience and allow the policy to reach maturity. This way, policyholders can secure the guaranteed sum assured along with any accumulated bonuses, which generally provides a more favourable financial outcome.

Policyholders should carefully review their policy documents to understand how the surrender value is calculated for their specific money-back policy.

They should also consider their financial circumstances, goals, and alternatives before deciding to surrender the policy, as it may have significant financial implications. Consulting a financial advisor can be helpful in making an informed decision about the surrender of a money-back policy.