What Happens When You Surrender Your Life Insurance Policy

Many people surrender their life insurance policies for diverse reasons. For example, some might realize that their existing policy is unsuitable for their financial goals. This happens when people purchase insurance policies solely for tax benefits or for the fulfillment of a particular purpose which loses relevance. They later realize that it doesn't add much value to their overall investment portfolio or life coverage. In this situation, surrendering the policy before its maturity becomes the only viable option. 

On the other hand, many people surrender their policies since they cannot keep up with the premium payments anymore due to financial constraints. That is why experts recommend using life insurance calculators before finalizing insurance plans so that you get a picture of the premiums payable and can plan your finances accordingly. But still, after all the financial planning, some situations may be unavoidable and surrendering the policy might be the only option. 

What should you keep in mind while surrendering your policy?

If you plan to surrender your life insurance policy, you must know the process and its terms. Let us have an overview of the same:

• Surrendering the policy means terminating it before its date of maturity
• The surrender value of the insurance policy (if any) will then be disbursed to the policyholder
• The surrender value is acquired when the policy is active for a set duration or upon completion of the compulsory lock-in period, if any. In most cases, the policies where premiums have been successfully paid for three years may get surrender values.
• You can find out this value through the website of your insurance company. This is usually a percentage of the value of the fund (in the case of life insurance policies that come with investment components) or the sum assured.
• Term insurance policies do not have any investment angle and hence lack surrender value
• You will have to pay the applicable charges for surrendering your insurance policy. These are deducted from the surrender value(if any), and the remainder will be paid out to you by the insurance company.
• You can apply to surrender your policy by filling up the requisite form and submitting the same to your insurer. The usually required documents include a cancelled cheque, the original document of the policy and KYC documents which are self-attested. You may also have to write the reason for surrendering your policy in this form.
• Upon submitting the application, it may require a processing timeline of seven to ten working days at the insurance company's end 
• When you surrender the policy, you automatically lose out on the coverage and all other benefits offered by the insurance plan

What are the implications of surrendering your policy?

In an ideal scenario, you should never surrender your life insurance policy since you will be left without coverage. Life coverage ensures your family's future financial security when you are not around. This is something that you should not compromise on, and it applies if the policy is meeting your needs and you are finding it difficult to pay the premiums. You can always talk to your insurance company about your difficulties and pay your due premiums with the penalties by saving up for the same. 

If the policy has an investment component, there are two values upon surrendering the policy. The first one is the guaranteed surrender value, which is a percentage of the premiums paid until the time of surrendering the policy while excluding the premium for the first year and any premium for the rider, if applicable. 

The second one is the special surrender value which is worked out on the sum assured, any bonuses accumulated along the policy tenure, and the total premiums that have been paid to date. ULIPs have lock-in periods of five years, and if you surrender within the first three years, the coverage will stop instantly. But the surrender value is paid out only after the completion of five years. 

Endowment plans usually have three-year lock-in periods where the whole amount paid is devalued, with zero refunds for customers, in case you surrender before completing this tenure. 

There is no such surrender value for term insurance plans, and the policy coverage and benefits will no longer exist. For instance, let's say you have a term plan with a sum assured of Rs. 50 lakh, and you have paid a premium of Rs. 30,000 annually for 5 years. Then, if your surrender your policy, you will forfeit the entire amount of Rs. 1.5 lakh that you have paid to date. 

However, if it is a limited payment term insurance plan, a small part of your paid premiums may be refunded. In addition, if you have paid the premium in advance, you may get an amount while surrendering your policy. Make sure to check all details regarding policy surrender in your policy document.

Are there any tax implications if you surrender your policy?

The surrender value of a life insurance policy is accepted as a tax-free benefit only if the following conditions are met:

• When a traditional plan, such as an endowment or money-back plan, is surrendered after the premiums for the first two years have been paid in full, the surrender value is tax-free
• If it is a single premium endowment or money-back plan, the surrender value is tax-free if it is surrendered after the first two years
• For unit-linked insurance plans (ULIPs), the surrender value is tax-free if the plan is surrendered after the first five years
• For policies issued on or after April 1, 2012, the surrender value is tax-free only if the sum assured exceeds ten times the yearly premium amount

If the surrender value fits the above criteria, the sum paid upon surrendering the policy is tax-free in the policyholder's hands. However, if the surrender value does not meet the abovementioned criteria, there will be dual taxation. 

• The Section 80C premium exemption claimed in the years that the premiums were paid would be revoked. Tax exemptions claimed in years when premiums were waived would no longer be applicable. As a result, you would have to pay additional tax on the exemptions claimed in previous years.
• Section 10D would not exclude the surrender amount received. You would be taxed at your current tax rate on the amount you get as surrender value because it would be considered "Income from Other Sources."

Conclusion: Should you surrender your policy? 

If it adds value to your financial portfolio, try to avoid surrendering your life insurance policy. Financially stretching a little to keep your insurance policy active is always worth it. Term plans, in particular, should not be surrendered since they do not have any refunds, and you will only have to get costlier term coverage (premiums increase with age and higher risks) later.