Unit Link Insurance Plan (ULIP)
Ulips or Unit Linked Insurance Plans help you to serve two goals in a single product: investment and insurance. It provides you a life cover and also lets you reap the benefits of the stock market, debt funds or both, as the case may be. Ulips have come a long way since its inception in 1971. The first Ulip was introduced by the Unit Trust of India (UTI) in 1971 and then by Life Insurance Corporation (LIC) in 1989.
How do Ulips work?
Ulips are products that provide you a combination of a life insurance policy and also an investment opportunity though a mutual fund in a single plan. Ulips are provided by life insurers so your payments to these companies when you buy a Ulip plan are called ‘premiums’ as primarily Ulips are more similar to insurance plans.
A portion of your premium is diverted towards the investment bit, which is the mutual fund portion: equity, debt, hybrid or as the case may be. There are fund managers who look after your investments. You are also allowed to switch between different types of funds to make the best ulip plan for yourself.
Lock-in period of a ULIP?
A Ulip insurance plan comes with a lock-in period of five years. However, Ulip being a combination of a life insurance policy and a mutual fund, both of which are long term investments, should be held for 15 years or more.
Costs associated with ULIPS
There are mainly five charges associated with a Ulip plan.
- Premium allocation charges: These charges are deducted upfront from your premium payment. An upfront deduction means that before your Ulip investment gets apportioned between the insurance and investment bit, some money is deducted as premium allocation charges. These charges are for the expenses incurred by the insurer in underwriting and selling the product to you.
- Fund management charges: These charges are deducted by the insurer for managing the funds in your Ulip plan and are capped at 1.35% by the IRDAI. FMC is deducted before the insurer arrives at the net asset value of the fund.
- Mortality charges: These charges are levied by the insurer to manage the insurance bit of the product. The calculation of these charges depends on the insured’s age, health condition, amount and duration of life insurance policy sought. The rationale behind mortality charges is that a company assumes the insured will survive until a certain age before the insurer will have to pay out the insurance policy. Mortality charges compensate the insurer in case the insured does not live until the insurer’s assumed age.
- Policy administration charges: As the name suggests, these charges are deducted to cover for all the administrative work done by the insurer in maintaining your policy.
- Switching charges: Your insurer can levy charges on you in case you want to switch between funds in the investment portion of Ulips. For example, if you were invested in an equity fund earlier and now you want to move to a different fund, say a debt or a hybrid fund, the insurer can levy a switching charge.
- Surrender charges: An insurer levies surrender charges for premature withdrawal and the charges depend on if you withdraw before or after the lock-in period.
Types of ULIPs
The categorization of ulips depends on the type of mutual fund associated with the product. There can be roughly 3 kinds of Ulip funds:
- Equity funds: Such Ulips invest most of its funds in equity or equity-oriented assets like stocks of various companies.
- Debt funds: Ulip plans which invest the premiums in debt instruments or money market instruments, government securities, bonds and likewise.
- Balanced funds: Here the premiums are invested in a combination of equity and debt market instruments.
- 4G or Whole Life Ulips: Few life insurers have floated new Ulip plans in the market which carry minimal charges and newer features. This has earned them the title of ‘new age ulips’, ‘whole life ulips’, or ‘4G ulips’. Some of the features of these new-age ULIPs include the removal of return on mortality charges (ROMC) on maturity and premium allocation charges. This category seeks to remove the negative bias against Ulips and increase awareness towards the new customer-centric changes.
Risks Associated With ULIPs
The risk associated with Ulip plans will depend on the type of fund attached to it. For example, an equity fund is riskier than a debt fund while a balanced fund shares the risk between the mix of equity and debt portfolios. The Ulip plan will carry the risk factor accordingly. Ulips are also riskier when compared to other investments. For example, ELSS, which also falls under 80 C, is a more diversified investment and is less risky.
If you compare Ulips to a standalone insurance plan or a mutual fund product, then the former will carry greater risks. Here’s why. The cost structure of Ulips makes it expensive and it becomes difficult to get returns that will cover you for the costs and help you add extra over and above that. Considering that Ulips are more expensive, we can say that the risk factor is on the heavier side.
Tax benefits associated?
The investment made in Ulips can be used to claim tax deduction under section 80C of the income tax act till a limit of Rs 1.5 lakh. Apart from this, the returns from the policy are exempt from taxation on maturity under section 10 (10D) of the income tax act.
Pros and Cons of investing in ULIPS
Pros
Long term goals: Given that the charges are high in Ulips and it invests in equities, a Ulip product is bound to be held for a long period of time to get the benefits of the markets. This means, ULIP may be a product to consider only when you want to achieve long term goals
like buying a house in the future, marriage, higher education of children, retirement, etc and liquidity is not a concern.
Switching: Ulips gives you the liberty to switch between equity, debt or mutual funds during the tenure of your Ulip plan to suit your requirements.
Tax benefits: While the investment made in Ulips is eligible for deduction under section 80(C), the returns from the policy are exempt from taxation on maturity under section 10 (10D) of the income tax act
Cons:
Benefits of standalone plans: All advisors are on board with the idea that if you buy life insurance and a mutual fund plan separately then the chances of you getting the real benefits of both these products are way higher than a Ulip, even after accounting for the investment you make in each of them.
Returns are compromised at times: Ulips may earn good returns for you due to the investment element but the long series of high charges at times compromise the returns in the end.
Volatile returns: Returns are also very volatile in Ulips but that goes with any investment that has an equity element in it.
How does ULIP compare with other investment options under 80 C: Comparative analysis
| Sr No. | Particulars | Ulips | ELSS | PPF |
| 1. | Lock-in period | Five years | Three years | 15 years |
| 2. | Tax benefits | 80C and returns from policy on maturity are exempt under section 10 (10D). | 80C | 80C and maturity amount is exempt from taxation too |
| 3. | Taxation | Gains are taxable depending on the underlying asset | Gains above Rs 1 lakh in any given financial year is taxable under LTCG at 10% | None |
| 4. | Underlying assets | Equity, debt and balanced | Equity | Fixed-income oriented |
| 5. | Risk (when compared to each other) | Highest among the lot | Not as risky as Ulips | Considered risk-free with guaranteed returns as it is backed by the government |
| 6. | Charges | There are at least five charges in Ulips:
|
Expense ratio is mostly in the range of 1.05 to 2.25%. Very few plans have an expense ratio of more than 2.25% and may range up to 3% or more. | One-time account opening charge of Rs 100 |
Things to keep in mind before selecting a ULIP plan
Things to keep in mind before investing in Ulips are not different from parameters that you need to consider before investing in any instrument.
Finances and goals: First and foremost you need to assess the funds you have at hand and what is the goal you want to achieve through this investment. You should consider investing in Ulips for long term life goals any other life goals that don’t require premature withdrawals or redemptions. The charges levied, in that case, will neutralize your gains or make it negative in some cases.
Risk appetite: Assessing your personal risk appetite will help you to know which Ulip should you go for: an equity fund Ulip will carry a higher risk than a debt-fund Ulip.
Charges: It is essential for you to do proper research on the product and look at all the charges levied to understand where do your affordability lie.
Do keep these things in mind, do your research and consult your advisor before investing in Ulips.
