Ravi Chandran
Thinking of cashing in that life assurance policy because you are running out of cash? Don’t be too hasty; your investments, particularly life assurance endowments, give you other options, including favourable loan facilities.
By: Nithila Vijayan/
All too often, investors who are short of money cash in their life assurance policies. This is not a wise thing to do. In most cases, it is better to borrow against the value of a policy than forfeit the policy and its risk cover and/or investment potential.
You incur losses when you cancel a policy by allowing it to lapse or when you cash it in (surrender it) before it reaches maturity. These losses can be significant, particularly if the policy covers you against dying or being disabled.
Universal policies, which give you both risk assurance and an investment portion, are the policies most seriously affected by the costs of lapsing or surrendering, but you could pay significant penalties if you cash in an ordinary investment policy too.
The consequences of using a life assurance policy as a quick source of cash include:
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- You will probably receive a reduced investment value, because there are penalties for early withdrawals. These are known as early surrender penalties.
- The underlying costs of a new policy – when you are in a position to replace the old one – may be higher than those of the old policy.
- In the case of a smoothed/stable bonus policy, you may lose guarantees on the capital, as well as pay additional penalties if investment markets are in the doldrums, because the life company will take the underlying, lower values of your policy into account.
- Taking out a new risk assurance policy on your life may cost you far more. In fact, you may not be able to get a new policy when you are older and your state of health has changed for the worse.
- The premiums on risk assurance against death and/or disability may increase more rapidly with a new policy. If your existing policy is what is called a “robust” policy, it has a guaranteed level premium. However, such policies supply the level premium at a cost: your premiums are loaded in the early years (in other words, you pay more than you would otherwise), so you can enjoy what is effectively a discount in later years. If you cancel halfway through the policy term, you have already paid the higher premiums, but you lose the benefit of the premium remaining unchanged (and therefore relatively low) in the long term.
Then there are risk policies that work the opposite way: they give you low premiums to start with, guaranteed for a limited period. They are often called “fragile” policies, because the premiums are likely to increase after the guarantee period – usually no more than a year. For example, if a life assurance company has more claims than expected in a single year, it will increase the premiums the following year, and fragile policies offer no protection against this.
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This kind of policy is not as expensive to cash in, but then you have to take into account the cost of taking out a new policy to replace it. If you need a pure risk policy, the danger is that it could be more expensive than the old one. Not only could the life company have raised premiums because of an increase in claims, but your health might have deteriorated, making you a higher risk to the assurance company.
Your choices
So what do you do if you can no longer afford the life assurance premiums and/or you need cash urgently?
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You have numerous options, but your main objective should be to ensure that you do not lapse or surrender the policy. You can:
1. Make the policy paid-up
In the case of an investment (endowment) policy, you can make the policy paid-up. In other words, you make no further contributions, but leave the accumulated capital invested.
2. Negotiate with the company
If you have a policy with both a risk and an investment component, you may be able to negotiate with the life company to do one of the following:
- Change the existing policy to reduce the investment portion of the premium while retaining the life assurance portion; or
- Convert the policy to another type of policy (for example, risk only) that would allow you to retain your life cover while reducing the policy premiums by stopping payments into the investment portion; or
- If you have accumulated an investment portion, you may be able to use this money to pay the premiums for the risk portion.
3. Borrow from your policy
A life assurance policy is an asset against which you can borrow money. You cannot borrow money from a retirement annuity or a preservation fund.
Life assurance companies will lend you money in two ways: as unitised, no-interest loans and as interest-bearing loans. Some companies use both methods, while others only offer you one. Both have their advantages and disadvantages.
4. Use your policy as collateral for a bank loan
A better option than borrowing against your policy might be to use the value of your policy as collateral for a loan.
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