Understanding ULIPs — should you invest?

For many years now, ULIPs were one of the most maligned and mis-sold financial products around due to huge upfront commissions and lack of clarity on charges, leaving customers unhappy. It was promoted as a get-rich-soon scheme, with insurance companies promising unrealistic returns in addition to tax benefits and life insurance with just minimum premium payments.

In 2010, IRDA stepped in to clean up the mess and lay down tighter guidelines to bring in more transparency in charges and capping of expenses.

So what exactly is a ULIP?

ULIP means Unit-Linked Insurance Policy (Plan) — a hybrid investment product that bundles life insurance as well as investment linked to the market, like a mutual fund.

If you’ve read our previous posts on insurance and mutual funds, you would know that:

Life insurance is for insuring your family from the loss of your income in case something untoward were to happen to yourself. For this, you pay a premium every year till the policy is in force.

Mutual funds are an investment product which let you indirectly invest in equities and debt

So a combination of both these options in a single product should be good, right? Let us find out.

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Investment

– ULIPs allow investments in Equity, Deb and Hybrid/Balanced Funds depending on your risk appetite and goals

– When you invest in a mutual fund at the NAV (Net Asset Value) for that day, that is your buying cost

– The total amount divided by the NAV is the number of units you are allocated. Likewise when you sell, the difference being your profit/loss as applicable

– In a ULIP, the premium allocation charge (including initial & renewal expenses, commission etc) gets deducted upfront, leaving you with lesser units compared to a mutual fund for the same amount

– Every year, expenses like mortality charges, fund management fees, policy/administration charges etc get deducted by cancelling units, further reducing your overall unit holdings, and overall investment value and return

– Expenses are high in the initial years and taper off over a longer period, so it makes sense to stay invested for 10–15 years

Portability

– Mutual funds offer the option of porting out if you’re not satisfied (subject to a lock-in of 3 years for Tax-Saving Funds)

– In a ULIP you can “switch” — meaning you can move your investment in a policy from one fund to another

– Switching lets you move to a debt fund when the markets aren’t doing well, and to an equity fund when the stock market is on a roll. Use this option wisely as timing the market is never a good idea

– Porting between different ULIPs means paying front-end costs once again, as well as higher mortality charges for the insurance cover

Charges

– Cost structures differ in a mutual fund and a ULIP, with the former being simpler

– With most investors now preferring to invest in mutual funds directly, ULIPs with their over half a dozen charges can appear an expensive proposition though their fund management fees could be lower

Tax Benefit

– Like insurance premiums and tax-saving mutual funds, ULIPs too offer a tax benefit up to Rs 1.5 lakh under Section 80C of Income Tax Act, 1961

– For ULIPs purchased before 01-Apr-12, premium should be less than 20% of sum assured, and less than 10% of the sum assured if purchased after 01-Apr-12

– Minimum lock-in period for ULIP is 5 years v/s 3 years in a tax saving mutual fund. Returns on maturity from ULIPs are tax free as well

– If the ULIP is surrendered before maturity, there are no tax benefits and previously claimed tax benefits will be reversed

To invest in a ULIP or not?

A ULIP remains a complex product for many, and works best if you have a very good understanding of the product, associated charges and risks, as well as the patience to wait for at least 10–15 years or so to get a good return on your investment. If not, just stick with a basic term plan for insurance, and mutual funds for investment and you’ll be fine :)


Originally published at www.getwalnut.com on October 10, 2016.

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