ULIP (Unit Linked Insurance Plan), a hybrid financial product that offers a mix of insurance as well as financial growth, appears to be the best of both worlds: insurance and investing.
However, before going into this product, one needs to analyse if this product is suited for him/her and what are the priorities besides the nuances of the ULIPs per se.
“Every financial product in the market exists because there are underlying needs and varied customer personas that require those instruments,” says Subhrajit Mukhopadhyay, Executive Director, Edelweiss Tokio Life Insurance, while talking about ULIPs.
“ULIPs are insurance types that combine investing and insurance into one package. In these uncertain volatile times when nothing is permanent, growth with insurance protection is good to go,” says Venkatesh Naidu, CEO - Bajaj Capital Insurance Broking Ltd.
However, while this appears to be optimal for insurance as well as investing, there are several factors to be considered before you choose ULIP as your investment product.
The very first factor on which experts are unanimous is the timeframe. Only go into ULIPs if you have a long term horizon.
“ULIPs are worthwhile if the investment horizon is greater than 10 years, but they are not recommended if the investment horizon is shorter, say 3-5 years,” says Saurabh Jhunjhunwala – AVP - Insurance Products, Prabhudas Lilladher Wealth.
“ULIPs are best suited for individuals with a long term financial plan of wealth creation and insurance,” says Akhil Bhardwaj – Senior Partner, Alpha Capital.
If you need your investment to be liquid, i.e. easily convertible into cash on short notice, then a mutual fund is a better option. ULIPs have a lock-in period of minimum five years. During this time, you cannot redeem your money. Of course, not all mutual funds are liquid. ELSS funds also have a three-year lock-in period.
Thus, before making a decision to invest in any of the financial products, be clear about what you want to achieve from your money.
“Unless you are cognisant of what goal is being fulfilled by the financial product you have purchased, you will eventually become disillusioned and discontinue it,” says Mukhopadhyay.
Whether it is for retirement, children’s education or for other financial goals, a ULIP continued till maturity works as an advantage. It gives you the dual benefit of savings and protection, all in a single plan.
“ULIPs are not suited for short term investment or those who are looking for guaranteed returns,” says Naidu.
Also, ULIPs are suitable for people who do not have the time to put in the research that is needed for equities but want the benefit of equities with insurance.
“ULIPs are for individuals who are not savvy with the equity market or different fund options available with MF (mutual funds) but would like to benefit from long term capital appreciation with investment in equities,” says Bhardwaj.
“Insurance and investments should not be mixed in practice, but it may be an option for clients who do not have time and want to purchase a single product with multiple benefits and equity participation,” says an expert who did not want to be named.
ULIPs are classified into two types: single-pay and regular-pay.
Thus, you can choose the one-time investment option. Conversely, if the person wants to save money every year, they can choose the regular option.
ULIPs, as in any other financial product, have charges.
Costs applicable to ULIPs are mortality charges, premium allocation charges, fund management charges, and administration charges. An annual fund management charge and exit load may be applicable. “High charges tend to eat into your returns,” cautions Bhardwaj.
So, in the long run, your ULIP returns are likely to be equal or higher than in the case of mutual funds. The fund management charges for the ULIPs, however, are lower than mutual funds, being 1.35 percent and 2.5 percent, respectively. Moreover, Insurance Regulatory and Development Authority (IRDAI) mandates that the total effective charges on ULIPs should not exceed 2.25 percent.
“This means the total charges on a ULIP can never exceed what a mutual fund charges,” says Bhardwaj.
Considering the taxation issues on ULIPs, Naidu notes that if the policies are issued on or after February 1, 2021, premium less than ₹2.5 lakhs is tax free.
However, in case you have paid an insurance premium of ₹2.5 lakh or more for any of the previous years, the amount received (including the bonus) at the time of maturity will be taxable. If an individual has purchased multiple ULIP plans and the aggregate amount paid is more than ₹2.5 lakh, then it comes under the ambit of taxation.
Next, long-term capital gains (LTCG) tax will be applicable on ULIPs like the tax on all equity-oriented investments. Also, tax shall be paid (in the case of long-term capital gains) at 10 percent.
However, no taxation is imposed in the case of the death of an individual.
Initial rebate under section 80(c), maturity benefit/ death benefit is tax-free under section 10(10)(D), says Jhunjhunwala. Now, there is a cap on ULIP investments, i.e. Rs. 2.5 lakh, and any amount above that is taxable at maturity.
ULIPs have an advantage over direct equities or MF as there is a tax-saving component in them.
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.
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, a factor helpful for investors.
As flexibility to choose different funds option is available, as per your risk appetite, you can choose an appropriate fund. For example, if you have a higher risk tolerance, equity funds would be suitable for you. If you have a lower risk tolerance, debt or balanced funds would be the right choice for you.
ULIPs are suitable for every age group. So, young professionals can create long term wealth and accumulated amounts can be used for life goals.
If you are in your 30s or 40s, you can invest for child education/marriage & retirement planning.
“Any financial planning process has to be goal-linked and not product-linked,” says Mukhopadhyay.
Fund switch is an option given by the insurance company where you are allowed to move your ULIP investment from one fund to another within the same plan. You can choose to transfer your units partially or fully between different fund options. This helps you move out of loss-making funds and focus more on profit-making funds.
Many companies limit the fund switch in a ULIP policy. However, the best ULIP plans allow unlimited free switches. Typically, most insurance companies allow you 5-10 free switches per annum and levy a charge of ₹50 to ₹500 after that.
“Yes, ULIPs are ready-made products, but one should not sit with their eyes closed; therefore, in the event of market fluctuations, investors should switch their money or choose a balance fund to reduce risk,” says Jhunjhunwala.
How ULIPs work
In ULIP investment, a small portion of money is invested towards securing your life and rest is invested in equities. When you make an investment in ULIP, the insurance company invests part of the premium in shares/bonds etc., and the balance amount is utilised 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,” explains Bhardwaj on how insurance companies manage their ULIP portfolio.
We asked experts to compare ULIPs versus other similar financial products like MFs and ELSS.
“We have equity participation in all the products (ULIP, MF, and ELSS), and one should understand the risk of investment before entering into a contract,” advises Jhunjhunwala. Markets are volatile, but the higher the risk, the greater the reward.
Every financial product has its own set of advantages. Because ULIPs are bundled products, investing in them can provide all the benefits (EEE – exemptions, a type of tax benefit at all levels).
Mutual funds provide the flexibility to choose the amount; one can start the monthly investment at ₹500 and withdraw funds at any time, or even stop at any time, but there is no tax benefit.
ELSS can also assist in obtaining the initial tax rebate and allows for the withdrawal of funds three years after the initial investment date.
“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,” notes Bhardwaj.
PPF is backed by the Government of India and is a debt instrument with guaranteed returns and no equity participation.
Charges that may be levied by ULIPs
The fine print always needs to be scrutinised in any financial product. ULIPs are no exception. Please know the charges that your company may levy on your ULIP policy, before you commit.
Premium Allocation Charges - There are various tasks the insurer undertakes, such as underwriting the policy, medical tests, etc. For the same, these charges are applicable.
Administration Charges - The administration of the policy attracts a fee. This fee is charged every month; it is usually the same throughout the term or changes at a predefined rate.
Fund Management Charges - Capped by IRDAI at 1.5 percent annually and charged as a portion of the fund value, these charges go towards managing your funds. It is computed before calculating the NAV and hence will not reflect in the net-asset value.
Discontinuance or Surrender Charges - If the ULIP plan is surrendered prematurely within 4 years, then a discontinuance charge is levied. After the 5th year, no surrender charges are imposed.
Partial Withdrawal Charges - At emergency, investors have an option to prematurely withdraw from the ULIP plan after the first 3 years. However, early withdrawal attracts some penalties as per the policy terms.
Mortality Charges - These charges are levied by the insurer to provide death cover to the insured.
Switching Charges - Investors are allowed to change the fund where their premium is invested a couple of times every year without a charge. Post the free-limit exhausts, every switch attracts ₹ 100-500 charges as per the insurer’s terms.
Source – Bajaj Capital Insurance Broking.
Manik Kumar Malakar is a personal finance writer.