What to do with the insurance policies already taken, is the big question

The Union Budget presented for the next fiscal year has provided the necessary incentive for taxpayers to switch to a new income tax scheme. Individual taxpayers are free to choose the old scheme or the updated scheme as per his/her convenience. Under the old scheme, tax payers were claiming deductions based on different savings, expenses and loan repayments as per provisions of the IT Act. The revised scheme does not allow any such deductions and immediately provides a higher exemption limit. Therefore, individuals opting for the new scheme need not continue with their savings.

The situation provides an opportunity for individuals to continue or discontinue endowment policies (and also similar life cover instruments like Money back policies, ULIP etc.). Though ideally term insurance will be the best option for life coverage, many have contracted for endowment policies on the perception that it is also a saving instrument. If they have taken the insurance only as a saving measure, they now have the option to discontinue it. The following options are available when choosing a new tax scheme for endowment policies (and similar policies).

Surrender the policy

It is possible to surrender the insurance policy to the issuer. This means no more premium is payable on this and the life cover will also lapse. The insurance company will return what is called the surrender value. Surrender value is the amount the policyholder will get from the life insurance company if he decides to exit the policy before maturity. Surrender value varies from policy to policy and it is printed on the policy itself.

Do not surrender but stop paying premium

This would not be the only option available. One need not surrender the policy but simply stop paying further premiums. When one continues with the policy without paying any further premium, the policy will have what is called “Paid up Value”. In other words, the paid up value is the value payable at maturity of the discontinued policy (of premium payment).

Generally, a life insurance policy with an investment value earns some paid up value after at least 3 years in force (5 years for ULIPs). This means that policies like money-back endowment will have paid-up value after 3 years and ULIP will have market value after 5 years. To calculate the paid up value, multiply the number of premiums paid by the sum assured by the total number of premiums. This method will offer continuing life coverage at a reduced amount (paid up value) and maturing.

Allow it to lapse

By not paying premiums further, one can allow the policy to lapse if it has no surrender value. The premium paid will be a loss. But cash outflows for many more years in the future will be a big saving.

Taxation

The surrender value of a life policy is allowed as a tax-free benefit only if it fulfils some conditions with regard to the number of years premium paid. But as the surrender value eligibility matches this, the surrender value will be tax free. (Only if the policy was issued between 1st April 2003 and 31st March 2012, there are additional conditions). There is no change in the deductions allowed in earlier years on account of premium payment. For paid up value, the amount received on maturity will be tax free.

Takeaway

The revised income tax regime allows the discontinuation of insurance policies taken with intent to save. This should not be confused with the necessity of life insurance. One may need life insurance protection, and it may be appropriate to have term insurance for the amount of coverage required. The decision of surrendering, continuing the policy without further premiums, or letting it lapse depends on the individual's determination of opportunity cost.

(The writer is a retired banker)