Unit Linked Insurance Plans (ULIPs)
Unit Linked Insurance Plan is a great investment option. This is a kind of life insurance plan in which you will get an opportunity to build a hefty corpus with the convenience of a life insurance policy by investing in it. On investing in this scheme, the investor gets a rebate of 1.5 lakhs under section 80C of Income Tax. Along with this, you also get the facility of higher returns by investing in this scheme. If you are also planning to invest in this scheme, then first of all be aware of the advantages of doing so.
Many investors often associate ULIPs (Unit Linked Insurance Plans) with mutual fund schemes. By investing in ULIPs, they feel that they are investing money in some mutual fund scheme. However, this is not true at all. These two are different types of products.
ULIP is an insurance product. It is a different matter that in the initial years of the privatization of the insurance sector, insurance companies and their agents continued to present ULIPs as an investment product. In the earlier ULIPs, the commission of agents was very hefty. About 60 per cent of the first installment of premium used to go into the pockets of insurance agents. This was the reason that they were being sold wrongly. At the end, the Insurance Regulatory and Development Authority of India (IRDAI) caught sight of this side. They cracked down on this entire game. After this, ULIPs with low commission and high insurance cover started coming. ULIPs have improved a lot since then. However, even today they are sold wrongly.
Many relationship managers of banks sell ULIPs as bonds. Some intermediaries sell these as mutual funds that give guaranteed returns after five years. Also insurance cover is available free.
The question is, what exactly is a Unit Linked Insurance Plan or ULIP? The simple answer is that a ULIP is an insurance product with an investment component. Or as some insurance agents claim, these are like mutual fund schemes which also include the feature of insurance.
History of ULIPs
When Life Insurance Corporation of India (LIC) was under the umbrella rule, the insurance cover always had the feature of saving. This is the reason why insurance was essentially used for savings and tax saving purposes. Before privatization, it was sold saying ‘you will invest x amount, you will get x plus bonus’. At that time, endowment plans and insurance products with savings were dominated. After privatization, insurance covers started coming with investment feature. Investment options range from conservative fixed income to high-risk equities. This is the history of ULIPs.
How do they work?
A Unit-Linked Insurance Plan is a combination of insurance and investment. A portion of the premium is paid by the policyholder and is utilized to provide insurance coverage to the policyholder and the remaining portion is invested in equity and debt instruments. The aggregate premiums collected by the insurance company providing such plans is pooled and invested in varying proportions of debt and equity securities. Each policyholder has the option to select a personalized investment plan based on his/her investment needs and risk appetite. Each policyholder’s Unit-Linked Insurance Plan holds a certain number of fund units, each of which has a net asset value (NAV) that is declared on a daily basis. The NAV is the value upon which net rates of return on ULIPs are determined. The NAV varies from one ULIP to another based on market conditions and fund performance.
A portion of premium goes towards mortality charges i.e. providing life cover. The remaining portion gets invested funds of policyholder’s choice. Invested funds continue to earn market linked returns.
ULIP policy holders can make use of features such as top-up facilities, switching between various funds during the tenure of the policy, reduce or increase the level of protection, options to surrender, additional riders to enhance coverage and returns as well as tax benefits.
What’s the strategy?
Once you get enough life cover, you can start investing in mutual funds for your investment needs. There are advantages to this strategy. First, you get enough cover by paying a small premium. You then track the performance of your mutual fund schemes. You will not be able to do this work with an insurance plan like ULIP. If the investment portion of the ULIP plan is not doing well then you can just switch to another investment option. Selling it outright is not an option as then you lose the insurance cover. As you age, getting life insurance cover becomes costly and complicated.
Types of ULIPs
Depending upon the death benefit, there are broadly two types of ULIPs. They are-
- Type-I ULIP- Under this plan, the nominee gets the higher of sum assured and fund value.
- Type-II ULIP- Here, the nominee of the policy holder gets the sum assured and fund value in the event of demise of the policy holder.
There are a variety of ULIP plans to choose from based on the investment objectives of the investor, their risk appetite as well as the investment horizon. Some ULIPs play it safe by allocating a larger portion of the invested capital in debt instruments while others purely invest in equity. Again, all this is totally based on the type of ULIP chosen for investment and the investor preference and risk appetite.
What does IRDAI say in regard to ULIPs?
As per the IRDAI, with effect from 1st September, 2010, the following are the restrictions on ULIP policies.
- The lock-in period is 5 years (earlier 3 years)
- Except single premium payment plans, premiums have to be paid for a minimum of 5 years
Compelling reasons for you to go in for ULIP
- Market-linked returns
- Investment & life protection combined
- Flexibility to choose between basket of funds of a Fund House
- Income tax deductions (under 80 C & 10 (10) D of the Income Tax Act)
- Financial security post retirement
Understand these Terminologies: Charges that could be levied on the Policy
- Premium allocation fee
The charge is imposed beforehand on the premium amount. These are initial expenses incurred by the company in issuing the policy. These are charged on yearly basis as a percentage on the premium depending upon the premium payment term.
- Fund management fee
This is an aggregated sum of fees incurred in units invested in equity and debt instruments. These charges vary according to the type of fund & plan and are borne by the insured. These charges are payable on a yearly basis as a percentage depending upon the premium payment term.
- Policy administration fee
These are related to recovery of expenses borne by the insurers for maintaining the life insurance policy. These are however borne by the insured on a monthly basis as a fixed sum charged on the premium amount paid.
- Mortality fee
This is an expense charged by the insurer to provide life cover to insured which vary with the age & sum assured, risk, etc. of the insured. These charges are deducted on a monthly basis.
- Surrender charge
This charge refers to the deduction for full or partial encashment of premature units subject to the policy document. This charge is levied as a percentage of the fund value or a percentage of the premium amount.
- Fund switching charge
This charge is levied while switching from one fund to another & beyond the free switches allowed in a year. The charge is applicable for each switch.
- Discontinuance charge
On premature discontinuation during the lock-in period, this charge is levied.
Do they perform well in the market?
The performance of the various ULIP policies with reference to growth of units, depend on market forces & the efficient management of the investment by the appointed Fund Managers in various sectors of the economy. Due to the ups & downs of the market based on demand/supply & the state of the economy, the returns get averaged & coupled with life cover, the returns on the Units invested is modest.
- Avoid everyday hassle of managing stocks
- Multiple fund options to choose from
- Transparent product with no hidden charges
- Low surrender charges
- ULIP is a two-in-one plan in terms of giving twin benefits of life insurance plus savings
- Some of the policies offer partial withdrawals without breaking the units ensuring liquidity
- Flexibility in increase/decrease in Base Sum Assured
- Initially, the various charges look to be costlier. But it has to be remembered that these charges look costly as viewed within the lock-in period (short term). The charges tend to taper off during the period after the lock-in period.
- Mortality charges levied have no fixed fee but based on a lot of other factors (such as age of the insured, cost of insurance & applicable sum assured).
- Due to the nature of the Unit-linked Funds, only a handful of the companies can guarantee the price of the units as this product is different from the other traditional insurance products & are subject to market & other risk-based factors.
- Very few insurance companies offer a discount on the premium that too is available only when the policy is purchased directly from the website of the company concerned; this acts as a dampener for attracting prospective customers.
- Charges such as Premium Allocation, Policy Administration & Fund Management offsets any growth which is achieved over the years during the short term period.
Differences between Mutual Funds and ULIPs: Whether you choose to invest in ULIPs or Mutual Funds, you can base your decision on these factors.
- ULIPs come with life cover alongside investment benefits, while Mutual Funds only offer investment benefits.
- If you are looking for long-term investment while providing protection to your loved ones, ULIPs should be your pick. Mutual Funds, on the other hand, are ideal to accomplish financial goals for your near future.
- With Mutual Funds, you can redeem the units at any time because of flexible withdrawal options. While regular funds don’t come with any lock-in period, for tax-saving Equity-Linked Savings Scheme (ELSS) schemes there’s a 3-year lock-in period. However, when it comes to ULIPs, they have a minimum lock-in period of 5 years.
- In terms of tax benefits, when it comes to Mutual Funds, you can claim deductions only for ELSS schemes. For ULIPs, you can get tax benefits on the premiums paid under Section 80C of the Income Tax Act, 1961. Under Section 10(10D), even the maturity amount is tax-free. However, those ULIPs issued after February 1, 2021, will be treated as capital gains if the annual premium is more than ₹ 2.5 lakh.
- When it comes to expenses, liquid Mutual Funds have no entry or exit fee. However, for ULIPs, there are premium allocation charges, administration charges, fees for managing funds, etc.
Keep these things in mind before investing in ULIP
1. ULIP plans have flexible investment options
A ULIP policy holder can choose to invest their premium in either equity options or debt or even a mixture of both, depending on their risk appetite. Someone who doesn’t mind high risk can choose ULIP investment options in equity funds while someone who is more cautious can invest in mutual funds.
2. ULIPs have a top-up option
In some cases, a policyholder can change the premium amount they’re putting into the ULIP plan and are not obligated to put a fixed amount each time. ULIP policies allow investors to “top up” or add extra funds to their existing investment amount.
3. Newer ULIP plans don’t have transaction charges
ULIP plans are a smart and secure first step into investing. However, older policies still come with a number of transaction charges related to premium allocation, mortality change, and fund management. Before investing, ensure that the policy is newer and eliminates these charges after a few years. For example, the Future Generali Easy Invest Online Plan starts with a 5% premium allocation charge that reduces to 2.5% after two to five years. After six years, the charge is fully eliminated.
4. ULIP plans are tax deductible under Section 80C
A ULIP policy is a tax deductible investment under Section 80C of the Income Tax Act 1961. This means that premiums of up to Rs 1 lakh are tax-free for the investor, making ULIP plans an attractive investor for first-timers. Even when the plan matures, the final amount is tax-deductible under Section 10 (10D) of the Income Tax Act 1961.
5. Lock-in period ensures discipline
A ULIP policy can come with lock-in periods of around five years, meaning that the investor must continue to add money into the policy for that time frame. The lock-in period encourages investors to save consistently and build their savings. After the lock-in period, investors can withdraw a part of their money if they want to or even discontinue the ULIP plan.
6. ULIP plans are strong long-term investments
Despite lock-in periods and transaction charges, ULIP policies are popular long-term investments. They require regular payments to remain active, teaching investors to be more disciplined while also increasing wealth. The lock-in period motivates investors to keep money in the market and ride out fluctuations with high returns, as well. A ULIP plan also allows investors to mix and match assets, making a diverse portfolio— Future Generali Future Opportunity Fund is one such plan.
7. Different premium payment options
ULIP policies are famous for their flexibility that also includes the payment structure. Investors have three different choices when it comes to paying premiums: single premium plan where the full investment is paid in a lump sum, regular premium plan where a fixed amount can be deposited for the duration of the ULIP policy, and limited premium plan where the amount is paid for a certain number of years.
8. A ULIP policy has the potential for high returns
One of the best parts of ULIP plans is that the return on investment can be potentially very high— even in double digits. When the premiums are invested smartly, in different types of assets and in tax-saving funds, the investor reaps huge benefits. A ULIP policy can be profitable, tax-savvy investment.
9. Maturity dates can be deferred
Some ULIP plans allow the investor to defer their maturity date, meaning that the date at which the policy matures and the money can be fully withdrawn is extended to the future. The main benefit of having a policy that allows the extension of the maturity date is that an investor can minimize risk in case the date falls in a market slump or decline. If the ULIP policy matures when the markets improve, the investor will see higher returns in the end.
10. ULIP policies help family planning
One of the most attractive aspects of a ULIP policy is that it offers insurance coverage and death benefits. So if the investor dies suddenly, their family can fall back on the ULIP and get financial security. ULIP plans are also good for family planning like retirement and children’s education, and any emergencies.
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