Investors are constantly on the lookout for avenues to make different financial investments for maximising returns. There are numerous financial avenues available in the market today, such as mutual funds, insurance plans, fixed deposits, among others. One of the popular and reliable instruments for wealth creation is a Unit-Linked Insurance Plan (ULIP).
ULIPs offer dual benefits of insurance combined with investment. The premium paid towards the scheme is divided into two portions, for life coverage and for investment in money market instruments. Here, we will explore the concept of ULIPs, its features, benefits and other aspects that investors should know before investing in them.
What is ULIP?
Unit Linked Insurance Plan (ULIP) is a combination of insurance and investment. The goal of a ULIP is to offer wealth creation and life cover. Under this, the insurance company sets aside a portion of the investment towards life insurance and the remaining is based on equity or debt or both to match the investor’s long-term goals such as retirement planning, children’s education, etc.
How does ULIP work?
The investment made in a ULIP goes partly towards shares/bonds, etc., and the remaining amount is utilized by the insurance provider to offer an insurance cover to the investor. ULIPs are managed by fund managers hired by the insurance company just like fund managers in the mutual fund industry. Thus, an investor is spared from keeping a close track of the investments.
ULIPS allow investors to switch the investment portfolio between debt and equity depending on personal risk appetite and one’s market knowledge. This flexibility is a huge factor that contributes to the popularity of ULIPs.
In the year 2010, the Insurance Regulatory and Development Authority of India (IRDAI) regarding ULIPs announced an increase in the lock-in period from 3 to 5 years. However, since insurance is a long-term product, an investor may not necessarily fetch the benefits of the policy unless he/she holds it for the entire policy term ranging from 10 to 15 years.
Some of the benefits of investing in ULIPs are:
- Life cover
ULIPs offer a life cover combined with the benefit of investment. It provides security that an investor and his/her family can rely on in case of emergencies, including an untimely death of the investor, etc.
- Income tax benefits
Premiums paid towards a ULIP are eligible for a tax deduction under Section 80C. The returns from the policy at maturity are exempt from income tax under Section 10(10D) of the Income-tax Act. Premium paid on ULIPs are eligible for a deduction under Section 80C up to a maximum of Rs 1.5 lakhs during a financial year.
- Long term financial goals
Those who have long-term goals such as buying a house, marriage, children’s higher education, etc., can invest in ULIPs since the funds invested in these get compounded. Thus, the net returns are often higher even if one wants to exit after the 5 year lock-in period. In comparison to other avenues, such as savings accounts or FDs, ULIPs come with higher benefits. However, under ULIP, the idea is to ensure that the policy keeps going for a longer time to fetch maximum benefits.
- The flexibility of a portfolio switch
Since ULIPs allow investors to switch their portfolio between debt and equity depending on individual risk appetite and knowledge of the markets.
Things to consider as an investor
Following are some important factors an investor should consider before investing in ULIPs:
- Measure financial goals
If an investor’s financial goal is wealth creation and retirement savings, ULIP is an ideal investment option available.
- Compare ULIP offerings
After determining the financial goals and the type of ULIP to meet those goals, the next step is to compare the ULIP offerings available in the market. Investors must look for comparison factors such as background expenses, premium payments, performance of the ULIP, etc. It is also important to investigate the nature of funds selected for investment to ascertain the returns.
- Risk factor
ULIPs are not as diversified as ELSS. Therefore, the risk in ULIPs is higher when compared to ELSS.
- Investment horizon
ULIPs come with a lock-in period of 5 years. If an investor surrenders the ULIP in the first three years of investment, the insurance cover ceases immediately. However, the surrender value is paid only after three years.
- Transparency of the product
Financial products like mutual funds are very transparent as all the charges are clear and declared upfront. However, ULIPs have complicated charge and fee structure that makes it difficult for investors to know about them. Products like mutual funds have clearly demarcated funds like equity, debt and hybrid funds which make it easier for investors to determine the risk involved in that particular investment.
- Mixes up insurance and investment
Investors take heart in knowing that they would get the dual benefit of investment and insurance by opting for ULIPs. But due to complicated fee and charges structure, it may not be wise to combine the both in a product. Separate investment products like mutual funds and term insurance may help you achieve the benefits of having an insurance and an investment plan.
Types of ULIPs
ULIPs can be categorized as per following broad parameters:
Based on funds that ULIPs invest in
- Equity Funds: Under this category, the premium paid is invested in equity markets and is subject to higher risk.
- Balanced funds: The premium paid is divided between debt and the equity markets to minimise the overall risk.
- Debt Funds: Premium is invested into debt instruments with lower risk and lower returns.
End use of Funds
- Retirement Planning: This type is ideal for those who are planning for retirement days while still being employed.
- Child Education: Ideal for those who have a long-term goal of saving for a child’s education or any unforeseen circumstances.
- Wealth Creation: This allows investors to build sufficient corpus that can be utilized for a future financial goal.
Death benefit to policyholders
- Type I ULIP: This category pays the assured sum value or the fund value, whichever is higher, to the nominee in case of death of the policyholder.
- Type II ULIP: This type pays the assured sum value along with the fund value to the nominee in case of the death of the policyholder.
ULIPs attract investors because of their flexibility and scope of customization. While these are preferred as safe investment choices, investors must carefully weigh their expectations against the returns that are offered by ULIPs. This will help in maximising benefits in the long run.
- How to buy a ULIP?
ULIP products are offered by many insurance companies in India. An investor can explore various options online before contacting the insurance provider to invest in the same.
- Is there any fund switching charge in ULIP?
An investor can make a fixed number of free switches from fund options available every year. Each switching may attract charges of up to Rs. 100-500 subject to the insurance provider’s terms.
- Is ULIP a safe investment?
ULIPs are safe from a long-term perspective. Since these come with a 5-year lock-in period, it is important for investors to monitor fund performance regularly.
- Are ULIPs better than mutual funds?
ULIPs offer the dual benefit of insurance cum investment, while mutual funds are purely meant for returns generation through investment. ULIPs often charge higher fees as compared to mutual funds and are less transparent. An investor should weigh the pros and cons of each against personal financial goals before making a decision.
- What is the death claim payable in a ULIP?
The death benefit offered in ULIPs is the amount payable to a nominee in the event of the policyholder’s death during the policy term.