The tax season just ended and now that you have time to rethink, you may realize that in the last-minute rush the agent convinced you to buy a policy that you don’t really need. But now that you know there is a problem, what do you do? Discontinuing and surrendering the policy is an option, but it may be costly.
Here are three costs that you need to take into account before you make any decision.
Insurance companies levy this charge on almost all policies. However, how much you pay would depend on the kind of policy you have and the period for which you’ve held it.
Also See I Need to Know (PDF)
Says Rahul Aggarwal, director, Optima Insurance Brokers, “The insurance regulator has capped discontinuance charges on all unit-linked insurance plans (Ulips) sold on or after 1 September 2010. There is no such upper limit on charges for other insurance products and on Ulips sold before the new guidelines came into force.”
Ulips issued after 1 September 2010: The new guidelines issued by the Insurance Regulatory and Development Authority (Irda) encourage you to stay invested during the lock-in period of five years. You will have to pay up to Rs 6,000 if you discontinue before the lock-in period and none if you discontinue after this period.
Ulips issued till 31 August 2010: If you bought your policy before the new guidelines came in force, you may have to bear charges as high as your annual premium. Since the charges were not capped then, they depend on the policy and the insurer. However, discontinuance charges would, typically, taper down to nil by the end of six-seven years.
Traditional plans: The discontinuance charges on traditional products, such as endowment or money-back policies, are still not regulated and are very high. The charges can eat into a significant part of the returns from the policy.
This is the value you get after paying all the charges. Depending on the plan and period of holding, this may even go down to nil. Explains Vinay Taluja, principal officer, Bajaj Capital Insurance Broking, “For traditional products, insurers generally don’t pay back anything if the policy is discontinued within three years.”
For traditional plans: The method of calculating the value varies between products and companies.
Though few traditional plans offer a surrender value immediately even if the policy is discontinued after one year, the Insurance Act, 1938, mandates that the insurer pays a surrender value after three years. “The surrendered value has to be equal to at least 30% of the premiums paid, excluding the first-year premium, less the cumulative benefit already paid,” says Taluja. But generally, the higher the investment tenor, the higher will be the surrender value.
For Ulips: The fund value minus discontinuance charges is your surrender value in Ulips. Since the discontinuance charge depends on whether you bought before or after September 2010, the surrender value too depends on that.
In fact, when you would receive the surrender value will also depend on when you bought. For older Ulips, you could get the surrender value immediately, but the new Ulip guidelines facilitate the payment only after the lock-in period.
The tax liability may increase in some cases. If you bought your Ulip before September 2010 and surrender your policy within five years (though the lock-in period is of three years), you will forgo the tax benefit you claimed in the past. “Remaining invested for specified period is necessary to claim any tax benefit. For Ulips the period is five years. If a Ulip holder surrenders his policy within five years and gets back a surrender value in the same time frame, he needs to pay tax,” says Subhash Lakhotia, an independent tax expert.
Other products pay the surrender value only after three years and, therefore, do not attract any tax liability.
The amount of tax would depend on the marginal tax rate applicable at the time the tax deduction was claimed.
What to do
If you have a Ulip, bought before or after September 2010, it’s better to stick with it since Ulips work only in the long term. It is precisely for this reason that the regulator has discouraged surrender before five years by removing the discontinuance charge completely after the lock-in period. Moreover, if you have an older Ulip, the tax liability would be an additional burden apart from the discontinuance charge and diminished surrender value.
If you are into a traditional plan, remain invested at least for three years as surrender penalties are still not capped and are high.