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A LIFE insurance policy is an instrument that can promise an ideal mix of long term investment returns, protection against bad kismet and outstanding tax benefits. Ideally therefore, this instrument should be held till maturity in order to allow it to perform the objective with which it was bought.
However, at times we find ourselves in a spot where we need to meet instant financial demands that may arise due to an unforeseen circumstance. The life insurance policy has built-in features to allow for such occasions. Legally, as per the Transfer of Property Act 1874, a life insurance contract is treated as a movable property. Like any other property it has a value. The value of a life insurance policy is determined by the cash value of the policy at any point in time.
Since it is a property and it has cash value attached to it, it is accepted as collateral by major financial institutions against a loan. In case of market-linked policies, a policyholder can surrender part of the cash value in case of requirement of liquidity. Many traditional savings products also offer loan facilities against the policy's cash value. All in all, although a life insurance contract can fulfil the immediate need of a paucity of cash, there are some pros & cons attached with it.
THE BRIGHTER SIDEo The first major benefit of a partial withdrawal or surrender of a life insurance contract is that its proceeds are tax free. However, the customer must ensure that the Sum Assured of the insurance policy is always five times the annual premium to ensure his or her tax-free return status.
o Usually, a traditional policy can be assigned to the insurers for a loan against the policy's cash value at a much lower rate than available elsewhere. This however, is dependant on the guidelines of different insurance companies.
o In case of a participating policy, the contract continues to participate in the profits of the insurer, thus ensuring that the customer does not lose out on the future benefits of the policy.
o The process of obtaining a policy loan from an insurance company, where available, is hassle free and usually doesn't involve any processing fee.
o The Principal amount can be repaid back or adjusted against policy's cash value at maturity, giving added convenience to the customer.
o In the case of ULIPs (Unit linked insurance plans) withdrawals can be made more than once during a policy year, thus giving extra liquidity opportunities to the customer.
o The withdrawals in case of ULIPs are without any assignments as it is a withdrawal from policy's account value and not a loan.
THE FLIPSIDEo The policy's cash value depends on the number of years the policy is in force. The longer it has been in force, the better is the cash value and hence the liquidity available to the customer.
o Usually there is a lock-in of 3 years before the money can be withdrawn or a policy acquires a surrender value. This is a regulatory guideline in the case of Unit Linked policies.
o There is usually a restriction on the loan amount (restricted to 80% to 90% of surrender value).
o The interest rate applicable on the policy loan is not guaranteed and may increases from time to time, like any other loan.
o Partial withdrawal in case of ULIPs may impose high withdrawal charge in the initial years. However, these charges tend to go down as the policies age.
Customers should however realise that terms can vary between different insurance companies and their assorted products. Hence they should check the liquidity options available before they invest in a particular policy.
Ref: NAGESWARA RAO MD & CEO, IDBI Fortis Life InsuranceThe Economics Times, 21st June 2009, Page No.10
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