Does it make sense to include ULIPs in your investment portfolio?

Choosing between so many investment options in the market can be confusing. To top it all, many people wish to avail twin benefits of wealth creation and insurance. While this may seem a bit overwhelming, it is not wrong to think of security along with earnings that can beat inflation in the long run. The idea of combining the benefits of investment with the security in insurance led people to seek a detailed understanding of unit-linked insurance plans (ULIPs) and their efficacy in reaching one’s financial goals.

Although, many question if investments in ULIPs are worth their hype. And it is indeed a very valid question as the returns generated by ULIPs are generally lower than market averages or even fixed deposits, at times. 

However, for some ULIPs continue to be a compelling offer because of the double benefit of investment and insurance. Many investors reiterate how the combined goals of wealth creation and life coverage had motivated them to park their earnings in them.

Why choose ULIPs?

In a market flooded with investment options, investing in ULIPs may not be a bad idea, though a lot depends on your idea of investments, financial goals, and myriad other factors. Like most other plans that offer the flexibility of paying money in instalments, you can choose to pay premiums either monthly, quarterly, half-yearly, or annually. A part of the premium amount is used to pay for the life cover while the rest is invested in various funds depending on the risk appetite of the investor.

Policyholders can decide between single premium and limited premium term options. Under the latter, policyholders can limit their premium payment to five years though they will have to wait for a longer tenure before withdrawing their returns. Many policyholders do not mind the prolonged policy term as they can divert their earnings to other investments post the premium paying term. Also, the compounding effect shows a palpable effect only when one gives enough time for the investments to mature. 

If you think that ULIPs are not risky, then think again as these instruments are embedded with the same level of risk as many mutual funds owing to their association with the market. This means that ULIP holders cannot escape the risk embedded in their investment portfolios. 

Transparency is another factor where ULIPs score over most other financial investments. Policyholders are inclined to know how their funds are being invested and if service charges are eating into their investments. This explains why all ULIP companies share details of their fund management charges, allocation charges, etc. upfront.

The current volatility in the stock market reiterates the importance of having ULIPs in your portfolio. This is because policyholders are allowed to shift their investments from equity to debt and vice versa depending on the quantum of risk they are willing to take.

Playing it right

While the single premium paying option may secure you against paying any further, it is worthwhile to invest in ULIPs through the systematic investment plan (SIP) mode paid monthly. The benefit of investing in ULIPs every month is that it reduces the average cost of units. Averaging the cost of units is possible especially in a bearish market when the shares are available at low prices. Apart, the investors can use the top-up option in ULIPs to park their investible surplus amount. Inducing frequent top-ups, especially, when the market is down not only reduces the overall cost of ULIPs for the policyholders but also the life cover.

Investment companies charge one to two per cent on the top-ups, which is much lower than the amount originally charged on premiums. Hence, adding money frequently through top-ups means buying more units at lower prices, thus, bringing down the total cost of investment. Since every amount invested in a ULIP includes an insurance component too, topping up of your investments can help enhance the life cover, too.

Choosing between multiple fund options

We rush to invest in mutual funds to gain from the market-linked returns. But the same investments tank when the markets go down miserably as in the recent case of the Russia-Ukraine war. The market is expected to suffer another blow with news of possible rate hikes by the US Fed. In such a scenario, ULIPs prove to be a worthwhile investment vehicle owing to their multiple fund options. Most ULIPs allow around five to nine fund options with varying asset allocations between equity and debt. Also, within the equity funds, investors can choose between large-cap and mid-cap funds. Some ULIPs may allow for exposure to multi-cap funds, sectoral and thematic funds too. The debt fund options may include liquid, short-term and long-term debt funds. 

Switching between fund options unbiased of the holding period does not attract tax, which means that you do not pay taxes on the amount shifted from one fund to the other. Most people prefer to stay invested in large-cap funds that include blue-chip stocks owing to their inherent stability. A portion of the money is diverted to mid-cap funds too. Too much volatility often causes investors to avoid thematic and small-cap funds. Timing the market is futile, which means that jumping from one fund to the other frequently does not help, especially, when you consider your long-term goals into account. 

However, for many, stability is a concern, which is why they shift their funds from equity to their comparatively less volatile debt counterparts around three to five years before maturity. This ensures that the money invested in equity funds accumulates to form a corpus that remains protected and fixed when shifted to debt funds. 

If you are unsure of how to allocate your funds, you must decide according to the life stage you are in and the financial goals that you have in mind. 

Tax benefits

You can avail tax deduction of up to ₹1.5 lakh on the premiums paid towards ULIPs under Section 80C of the Income Tax Act. Furthermore, the amount you receive on maturity is tax-exempt under Section 10(10D).

Naval Goel, Founder & CEO, PolicyX.com said, “ULIP offers life insurance benefits where the person has the freedom to decide the sum insured amount at the time of purchase of the plan, which is not available in mutual funds. It gives them added advantage to secure their lives of themselves with the help of riders and their family members in case of demise. Moreover, Since ULIP offers a life insurance facility that also gives tax saving options that gives additional opportunities to people to save money.”

Do ULIPs incur losses?

If all is good about ULIPs, then why do many personal finance advisors refrain their clients from buying ULIPs. Suresh Sadagopan, a Mumbai-based financial planner said, “It is an investment cum insurance product. If insurance is not needed for the client, we will be paying for it unnecessarily. One needs to be in the product for five years. One has the option to invest only in the specific funds in the ULIP, unlike in mutual funds where one can invest across schemes, across asset management companies. There is a possibility of concentration risk in the fund (as all the money may keep getting invested into two to three funds of the ULIP). If funds do not perform, one cannot do anything - one can only exit the ULIP, unlike in the case of MF where one could move money into other schemes.”

The returns from ULIPs are also on the lower side. Though investments in mutual funds entail risk, the same can be managed by choosing between different kinds of funds or allocating money wisely between equity and debt funds. This can be understood with the help of the following table.

The lock-in period in ULIPs is also a cause of concern. Barring equity-linked savings schemes, you will not find many mutual funds mandating you to stay invested for a particular period. However, since ULIPs are essential financial products with a greater weightage to the insurance component, insurance companies define their lock-in period before these can be redeemed. Most ULIPs have a lock-in period between three and five years, depending on the nature and structure of the investment scheme.

The risk factor in ULIP investments is always there as these are tied to market movements. This means that early exit may spell losses if a particular fund does not perform during that tenure. This implies that you must decide on your choice of funds in ULIPs not only based on their features but also depending on their fund performance.

Low costs and professional management are other attributes of mutual funds that one dare not ignore. There is no limit on the amount that can be charged by insurance companies selling ULIPs, though the Securities and Exchange Board of India has capped the expense ratio on mutual funds at 1.05 per cent.

While deciding on the ULIP you want to buy, compare its fund performance with how other equity funds have fared in the market.

Buying ULIPs can be beneficial if you can tie them up to your fiscal goals at different stages of your life. Though there are administrative costs involved in buying ULIPs, the amount one has to pay towards them is minimal, thus, serving you the bigger purpose of investing money in the market while ensuring that the nominees to your policies are well insured.

You must buy a ULIP only if

You are looking to stay invested for a long term

You are looking for a life cover built-in with your investment

You have a low to medium risk appetite

You are looking for investments that help save on taxes too.