Surrender Value in Life Insurance

Life situations change, and sometimes, you might find yourself needing to withdraw from a life insurance policy before its term ends. Since you have paid previous premiums until that date, you may wonder whether you can claim any sum from your insurance company. This is where the concept of surrender value comes into play.

Understanding surrender value can help you make an informed decision about whether to continue or discontinue your life insurance policy. Whether you are a policyholder or considering a life insurance plan, this guide will answer all your questions.

Surrender value is an amount that insurance companies give their customers if they terminate their policy before the maturity period. This amount is calculated based on the premiums paid, the tenure of the policy, and certain deductions by the insurance company.

If they opt out of their plans mid-term, they will get the total amount accumulated towards savings and the interest accrued on them. Nevertheless, insurance companies only give the sum after deducting a surrender charge from the total fund value.

Nevertheless, according to IRDAI's mandate, insurance companies cannot apply this surrender charge if customers liquidate the fund values of their life insurance plans after 5 years of purchase.

Surrender value typically becomes applicable after a specified period, usually after the policyholder has paid all the premiums for a year and completed a year term. Before this period, most policies do not offer any surrender value.

Let's understand how surrender value functions in your life insurance policy.

Premium Allocation

When you pay your premium, it gets divided into three main components:

1. Risk coverage (mortality charges)

2. Insurance company's expenses and profits

3. Investment or savings portion

The third component contributes to building your policy's surrender value over time.

Growth Pattern

Surrender value typically follows a progressive growth pattern

• Initial years: Little to no surrender value
• Middle years: Moderate growth
• Later years: Accelerated growth

This pattern exists because insurance companies need to recover their initial costs, such as agent commissions and administrative expenses, during the policy's early years, excluding specific charges like mortality charges, rider premiums, and other administrative costs.

In many cases, if the policy has accumulated bonuses, these may also contribute to the total surrender value.

Note: Surrendering a policy means you will no longer have life insurance coverage under that plan. It's a permanent decision, so weigh your options carefully.

Now that you understand the surrender value in a life insurance plan, you will also need to know its types.

There are two major types of surrender value, as mentioned below:

1. Guaranteed Surrender Value

The surrender value amount in this type is predetermined. You can find this value in your policy brochure. You will be eligible to get this amount only if you keep paying your premium for three successive years. In this scenario, you will get 30% of the total value you have paid, excluding the 1st year’s premium.

Guaranteed Surrender Value Formula:

Guaranteed Surrender Value = (Total Premiums Paid - Exclusions) × Surrender Value Factor

2. Special Surrender Value

Policyholders get a special surrender value if they stop paying premiums, but they do not request to surrender their life insurance plans. In such circumstances, the life cover stays in effect, and resultantly, the sum assured amount keeps decreasing with time. In such a scenario, they get a paid-up value instead of the sum assured amount.

Special Surrender Value Formula

Special Surrender Value = (Paid-Up Value + Bonuses) × Surrender Value Factor

Here, Paid-Up Value = Sum Assured x (Number of Paid Premiums / Number of Total Payable Premiums)

The surrender period is when a policyholder cancels their policy and receives the surrender value without incurring significant penalties or surcharges. It varies by insurance company and is based on the specific terms established by the insurance company.

Typical surrender periods range from a few years to over a decade, with many plans having a 5- to 10-year commitment period. The cost of surrender is the amount paid by the insurer if the claim is surrendered within the deadline. These charges usually decrease over time and eventually disappear at the end of the season.

Basic Surrender Value Formula:

Surrender Value = (Total Premiums Paid × Surrender Factor) - Outstanding Loans - Surrender Charges

An Example of a Surrender Period

For example, the plan may receive a cash advance of 10% of the cash value in the first year, decreasing by 1% per year until it reaches 0%. Policyholders who surrender their policies within the surrender period will receive less than the total premium due to this surrender.

After the surrender period, policyholders can generally receive the total value without paying a surrender fee. Understanding the timing is essential for financial planning, as it helps policyholders make informed decisions about when they will receive their policy's cash value and avoids unnecessary penalties.

Note: Timing and comparing premiums can be essential when choosing insurance policies. Always check the insurance policy specifications to understand the timing and associated fees.

The surrender value factor is a ratio of the total premium policyholders have already paid and the total premium they will have to pay until their terms end. It is expressed in percentage value.

Let’s assume that the premium amount is ₹ 10,000/year and that you have continued making policy payments annually for 5 years. If the policy's term is 20 years, the surrender value factor will be (5/20) x 100% = 25%.
For better clarification, examples delineating how guaranteed and special surrender value is calculated have been mentioned below.

Calculating Guaranteed Surrender Value in Life Insurance

Calculating Special Surrender Value in Life Insurance

Let’s consider that a policyholder has purchased a policy having a term of 20 years, and the premium amount is ₹ 10,000/year. The sum assured amount is ₹ 5 Lakhs. The policyholder then wants to stop paying policy premiums after 5 years.

In this circumstance, the paid-up value = ₹ 5 Lakhs x (5/20) = ₹ 1,25,000

If he/she wants the special surrender value after 10 years, the surrender value factor will be = (10/20) x 100% = 50%.

So, after 10 years, he/she will get a special surrender value of ₹ 1,25,000 x 50% = ₹ 62,500.

You will not get any surrender value from a plan that offers no maturity benefit. Since term plans do not have any maturity benefit, the insurance companies do not keep any portion of your premiums towards savings or funds for investment.

Term plans have no surrender value. This surrender value can be obtained through the endowment policy or ULIP.

Surrendering your policy allows you to access the cash value before the policy's maturity. To claim the surrender value of your life insurance policy, follow the steps below:

Step 1: First, you must review your life insurance policy for details on surrender value and any associated penalties.

Step 2: Once you’ve reviewed the policy details, inform your insurance company or agent about your decision.

Step 3: You will receive a surrender request form either online or in person. Fill out the form with the required information.

Step 4: Submit the form with the original policy document, identification proof, and bank details. You can do this both online and in person at a branch.

Step 5: Follow up with the insurer to check the status of your request. Once processed, the surrender value will be transferred to your account.

Compound Interest Growth

Surrendering Early

Interest and Charges

Yes, you must pay tax if you surrender your life insurance policy. This is because surrendering a life insurance policy can have tax implications, depending on the policy type, cash value received, and total premiums paid. The difference is considered taxable income if the cash surrender value exceeds the total premiums paid.

Policies with outstanding loans or withdrawals may also affect the taxable portion. Surrender charges can reduce the cash value but not directly affect the taxable portion. To manage tax liability, consult a tax professional, explore policy loans or withdrawals, and plan for the tax event.

Step 1: Wait Until the Surrender Period Ends

Step 2: Use Policy Loans or Withdrawals

Step 3: Review Policy Terms

Step 4: Compare Policies with Low Surrender Charges

Step 5: Consider Policy Exchange or Conversion Options

Step 6: Use the Free-Look Period

Step 7: Negotiate with the Insurance Company

You can discuss with the insurance company to negotiate lower surrender charges or explore alternative solutions.

By avoiding surrender charges, policyholders can maximize the value of their insurance policy and avoid penalties.

Understanding surrender value is crucial for making informed decisions about your life insurance policy. While insurance provides a safety net for accessing funds in emergencies, surrendering your policy should generally be the last option. Consider all alternatives and consult with financial professionals before making this important decision.

Remember that life insurance's primary purpose is protection for your loved ones. Any decision to surrender should be balanced against your long-term financial security goals and insurance needs.