While life insurance policies offer financial protection and investment opportunities, one of the critical aspects is the lock-in period. It has significant implications for liquidity, reversal of tax benefits, and the overall utility of the policy.
The lock-in period in life insurance refers to a specified duration during which the policyholder cannot surrender or withdraw the invested amount without incurring penalties or losing benefits. This period is set by the insurance provider and is mandatory for certain types of life insurance policies, such as unit-linked insurance plans (Ulips) and some traditional plans like endowment and money back policies.
Duration of lock-in
All Ulips have a lock-in period of five years, during which partial or complete withdrawals are not allowed.
Adhil Shetty, CEO, Bankbazaar.com, says, “ULIPs have a lock-in period of five years, during which partial or complete withdrawals are typically not allowed. After this lock-in period, you can withdraw full or partial amount, provided you have paid all premiums for the first five policy years. During the lock-in period, policyholders cannot withdraw their funds, but they can switch between different fund options offered within the ULIP. It is good to get in touch with your bank for more clarity while switching funds.”
Pension plans or retirement plans may have different lock-in periods depending on the specific product. They often have longer lock-in periods to ensure that the policyholder stays invested until retirement.
Pros and cons of lock-in period
Liquidity: Since the policyholder cannot access the invested funds during the lock-in period, this can be a drawback if he is in urgent need of finances and cannot withdraw from the policy without penalties.
Tax benefits: Life insurance policies offer tax benefits under Section 80C and Section 10(10D) of the Income Tax Act. However, these benefits are contingent upon the policyholder not surrendering the policy within the lock-in period. Premature surrender can lead to forfeiture of these tax benefits.
Long-term savings: The lock-in period encourages long-term savings and investment discipline. It ensures that the policyholder remains committed to the investment for a minimum period, which can lead to significant wealth accumulation over time.
Penalties on surrender: If a policyholder surrenders the policy within the lock-in period, he may face penalties. The surrender value, which is the amount received upon policy termination, is typically lower than the premiums paid.
Understanding policy terms
Before purchasing a policy, thoroughly understand the lock-in period and other terms and conditions. This helps in avoiding confusion after you have already purchased the policy.
Ensure that you have sufficient liquid assets or an emergency fund to cover any unexpected expenses during the lock-in period. This reduces the need to surrender the policy prematurely. Consider diversifying your investments across different financial instruments to ensure better liquidity.
What to do after maturity?
Once the lock-in period ends, investors should avoid withdrawing their funds immediately. Instead, they should monitor the performance of their investments. Lock-in period differs from the total number of investment years. Often in Ulips, the investment period is higher than the lock-in period. For example, if the lock-in period is five years, then the investment period could be 10 years. So, you have another five years to let your investment grow.
The lock-in period is a crucial feature. While it may restrict liquidity in the short term, it ultimately contributes to substantial savings. By understanding the lock-in period, you can avoid confusion about your policy.