11 Feb Unit Linked Insurance Plan (ULIP)
1. What is ULIP
Unit Linked Insurance Plan (ULIP) is a mix of insurance along with investment. From a ULIP, the goal is to provide wealth creation along with life cover where the insurance company puts a portion of your investment towards life insurance and rest into a fund that is based on equity or debt or both and matches with your long-term goals. These goals could be retirement planning, children’s education or another important event you may wish to save for.
2. How does ULIP work?
When you make an investment in ULIP, the insurance company invests part of the premium in shares/bonds etc., and the balance amount is utilized in providing an insurance cover. There are fund managers in the insurance companies who manage the investments and therefore the investor is spared the hassle of tracking the investments.
ULIPS allow you to switch your portfolio between debt and equity based on your risk appetite as well as your knowledge of the market’s performance. Benefits like these which offer investors the flexibility of switching is a huge factor contributing to the popularity of these investment instruments.
3. Lock-in-period of ULIP
One of the changes brought about by the Insurance Regulatory and Development Authority of India (IRDAI) in the year 2010 as regards ULIPs, was to increase the lock in a period from 3 years to 5 years. However, insurance being a long-term product, as an investor you may not really reap the benefits of the policy unless you hold it for the entire term of the policy which can range from 10 to 15 years.
4.Why you should invest in ULIPs?
- Life cover: First and foremost, with ULIPs you get a life cover coupled with investment. It offers security that a taxpayer’s family can fall back on in case of emergencies like the untimely death of the taxpayer, etc.
- Income tax benefits: Not many are aware that the premium paid towards a ULIP is eligible for a tax deduction under Section 80C. Additionally, the returns out of the policy on maturity are exempt from income tax under Section 10(10D) of the Income-tax Act. This is a dual benefit that you can claim with this policy.
- Finance Long Term Goals: If you have long-term goals like buying a house, a new car, marriage, etc., then ULIP is a good investment option because the money gets compounded. As a result, the net returns are generally more. This stands true even if you want to exit after the 5 year lock-in period in comparison to not having invested the amount at all and retaining it in a savings account or in the form of an FD. But, under ULIP, the mantra is to always keep the policy going for a longer time horizon to reap the best out of it.
- The flexibility of a portfolio switch: As already mentioned, ULIPS are usually designed in a way that they allow you to switch your portfolio between debt and equity based on your risk appetite as well as your knowledge of how the market is performing. Insurance companies, on the other hand, allow a very few numbers of switches free of cost.
5. Things to consider as an investor
Following are some important factors you should weigh in before investing in ULIPs:
- Personal financial goals: If your financial goal is about wealth creation and you want to save money for retirement, ULIP is one of the best options available.
- Compare ULIP offerings: Once you have determined your financial goal and the type of ULIP that will help you achieve it, the next step would be to compare the ULIP offerings in the market. Look for a comparison in the form of background expenses, premium payments, ULIP performance, etc. Also, investigate the nature of funds that the ULIP invests in to ascertain the returns from investments in the particular ULIP.
- Risk factor: Since ULIP investment is not as diversified as compared to ELSS, the risk in ULIP is probably a bit high compared to schemes like ELSS.
- Investment horizon: ULIPs have a lock-in period of 5 years. If a ULIP is surrendered in the first three years, the insurance cover would cease immediately. However, the surrender value can be paid only after three years.
6. Types of ULIPs
ULIPs are categorized based on the following broad parameters:
a. Funds that ULIPs invest in
i. Equity Funds: Where the premium paid is invested in the equity market and thereby is subject to higher risk.
ii. Balanced funds: Where the premium paid is balanced between the debt and the equity market to minimise the risk for investors.
iii. Debt Funds: Where the premium is invested in debt instruments which carry a lower risk but in turn also offer a lower return.
b. End use of Funds
i. Retirement Planning: For those of you who plan to invest for the retirement days while you are still employed.
ii. Child Education:You can iYou can invest with a long-term goal of saving to fund your child’s education or save for some unforeseen circumstances.
iii. Wealth Creation: You can make investments to build a heavy corpus that you can utilize for a future financial goal
c. Death benefit to Policy Holders
i. Type I ULIP: This pays higher of the assured sum value or the fund value to the nominee in case of death of the policyholder.
ii. Type II ULIP: This pays the assured sum value, plus the fund value to the nominee in case of the death of the policyholder.
7. Income Tax Benefits
Premium paid on ULIPs is eligible for a deduction under Section 80C up to a maximum of Rs 1.5 lakhs during a year. Further, the amount you receive on maturity is tax exempt under Section 10(10D).
8. Types of fees and charges
In every investment, there are various charges that need to be paid. In the case of ULIP, the charges can be broadly classified as:
a. Premium Allocation Charge
Premium Allocation Charge is deducted as a fixed percentage from the premium paid in the initial years of the policy. This is charged at a higher rate. The charges include the initial and renewal expenses and intermediary commission expenses. It is a front load charge as it is deducted from your premium paid.
b. Mortality Charges
This charge is to provide for the insurance coverage under the plan. Mortality charges depend on a number of factors like age, sum assured, etc., and is deducted on a monthly basis.
c. Fund Management Charges
Fund Management Charge is the fee imposed by the insurance company for the management of the various funds in the ULIP. It is levied for the management of the funds and is deducted before arriving at the NAV figure. The maximum charge allowed is 1.35 percent per annum of the fund value and is charged daily. Generally, insurers levy the maximum amount allowed in equity funds, while the charge on non-equity funds is much lower
d. Partial Withdrawal Charge
ULIPs have the option of partial withdrawals of funds. Some plans offer unlimited withdrawals, but some restrict it to 2-4 withdrawals. These withdrawals can be free for up to a certain limit or you can be charged based on your transactions.
e. Switching your funds
The moving of funds or investments between options is called switching. There are options to switch your funds for free up to a certain limit per year. Any further changes might incur a charge of Rs. 100 -Rs.250 per switch.
f. Policy administration charges
This charge is levied for the administration of the policy and it is deducted on a monthly basis by the cancellation of units from all funds chosen. This charge can be levied at a fixed rate or as a percentage of your premium.
ULIP as a mode of investment is a good choice given it offers the benefits of insurance with investment. With part of the investment spread across stock markets, you stand to gain higher returns. This also means that your investment is subjected to market risks. If your risk profile meets the trade off, this could be worth exploring.
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