Everything You Need To Know About ULIP Investing
In this article we shall discuss the A to Z pertaining to ULIP, right from what it means to its performance against mutual funds to its cost structure to its tax treatment. In short, here is your comprehensive guide to ULIP
While making investment decisions, people usually tend to gravitate towards products that give them more perceived value for money. Unit Linked Insurance Plan (ULIP) is one such category of products that many people invest in as they believe ULIPs pack in multiple benefits in a single investment. ULIPs seek to provide the dual benefit of providing individuals with an insurance cover along with investment in funds similar to mutual funds, thus making it an investment solution. They also give you tax benefits. ULIP was first introduced by Unit Trust of India (UTI) which was then running a mutual fund. Later, in the year 2005, when the Insurance Regulatory and Development Authority of India (IRDAI) laid down guidelines for ULIP, many insurance companies forayed into the ULIP business. Though the intent of ULIPs is to provide best of both the worlds, does it succeed in the same?
What are ULIPs?
Unit Linked Insurance Plan or ULIP, as is popularly known, is an insurance product which also doubles as an investment product. For most of the part, ULIPs are quite similar to a setup wherein you buy a term life insurance and invest in mutual funds.
How do ULIPs work?
Unlike other traditional insurance policies such as endowment or money-back, ULIPs are equity or debt market-linked. This means that market fluctuations do affect the performance of ULIPs. ULIPs are structured in such a way as to provide the benefit of both risk cover and wealth creation by investing in stocks, bonds or combination of both depending upon the investment plan you opt. When you invest in ULIP the amount invested in the form of the premium is adjusted for the relevant charges, which are stated in the policy itself.
Post this, a part of the net premium will be kept aside for providing life cover (that is also deducted as mortality charges) and the other part will be invested in the capital market via funds comprising of equity and debt depending upon the selected investment plan. Keeping your risk profile in mind, you have a choice to invest in plan variants and different fund choices made available by the ULIP. Every fund will have its unique risk rating as we see in the case of mutual funds. One thing to bear in mind is that ULIP plans come with a lock-in period of five years.
ULIP pools policyholders’ money and invests them into funds chosen by them. When the policyholder invests, depending upon the prevailing net asset value (NAV), he or she receives units similar to that of mutual funds. When the ULIP matures, the policyholder will receive the fund value on the date of maturity. The fund value is the total value of all the fund units across all the investment funds opted in the policy at the NAV during maturity. However, if in case the policyholder dies during the policy period, then the nominee designated in the policy or the beneficiary of the policy will get the higher of the following amount:
✓ Fund value on the date of demise.
✓ Pre-agreed sum assured.
✓ 105 per cent of the total premiums paid till the date of demise.
There are also such ULIPs available that offer both the fund value as well as the sum assured as a death benefit. Let us understand this with an example. Anil Kapoor has taken a ULIP plan for 15 years with Rs 10 lakh sum assured and he has been paying Rs 1 lakh every year as a premium. Now let’s say that unfortunately Kapoor dies in the sixth year of the policy. He has therefore paid total premium of Rs 6 lakhs. And let’s say the fund value on the date of his demise is Rs 8.2 lakh. This can be anything as it is market-linked. Then his nominee would receive Rs 10 lakhs (sum assured) which is the highest of all. However, if the ULIP has offered a double death benefit, then the nominee would receive Rs 18.2 lakhs (Rs 10 lakhs + Rs 8.2 lakhs) as death benefit.
Performance of ULIP
Even though the objective of a fund under ULIP is similar to that of a mutual fund, previously it was difficult to compare the fund performance of ULIP with that of a mutual fund as ULIPs did not subtract any other charges apart from fund management charge. However, with the removal of most of the charges in the online ULIPs, the fund performance has now become more comparable.
The above two tables show the category performance of ULIPs and mutual funds. Overall, the performance of ULIPs and mutual funds are in line with a difference of one or two per cent. However, it is only in the case of one-year large-cap and one-year aggressive allocation where the ULIP has outperformed by 8.8 per cent and 7.8 per cent, respectively. The performance of ULIP is only the net of fund management expenses. Other expenses have not been accounted in the performance.
Costs Involved in ULIPs : Unlike mutual funds, there are lot more costs involved while investing in ULIPs. So, let us have a look at them.
Premium Allocation Charges : Premium allocation charge is the percentage of the premium charged by the insurer before allocating the policy. It includes fees such as cost of underwriting, medical expenses, agent’s commission, etc. Post deducting these charges, the remaining amount is invested in the chosen investment plan.
Administration Charges : Administration charge is the fee charged each month by the insurer for the administration of your policy. These charges get directly deducted by redeeming the units proportionately from each of the funds you have selected.
Fund Management Charges : These are the charges that are levied by the insurer for managing the fund that you have invested in. This charge is computed as the percentage of the fund’s value and is deduced before calculating the NAV of the fund. According to IRDAI regulations, it should not be more than 1.35 per cent per annum.
Mortality Charges : Mortality charges are cost of life insurance coverage under the ULIP which is deducted on a monthly basis. These charges may depend on various factors such as the amount of sum assured, age of the assured, health history and many more. Charges get deducted proportionately from each fund you have chosen for investment by cancelling the units.
Partial Withdrawal Charges : ULIPs do allow partial withdrawal of funds post completion of its lock-in period of five years. Though some ULIPs allow unlimited partial withdrawals, yet there might be some ULIPs that restrict the number of partial withdrawals to three or four times for free. Thereafter, ULIPs may charge you for additional withdrawals which are called partial withdrawal charges which usually is a flat fee.
Switching Charges : ULIP does offer inter-fund switching. With this you can switch from one investment fund to another depending on your investment need and market conditions. Generally, in some ULIPs the number of switches allowed is limited to a certain number, but there are some ULIPs that may offer unlimited free switches. ULIPs offering limited switches might charge you for additional fund switches that you make during the policy term. Usually, switching charges may vary from Rs 100 to Rs 250 per switch depending on the insurance c omp any.
Discontinuance Charges : As we all know, ULIPs come with a lock-in period of five years. Hence, if you stop paying premium within the lock-in period, then your money will be locked in a discontinued fund. The same is applicable for the surrender of policy within the lock-in period as well. These charges are pre-decided by IRDAI and are almost the same across all ULIPs.
As can be seen there are numerous charges that are applied to a ULIP policy due to which most of the financial planners’ bash ULIPs. However, ULIPs are no more a high-cost product than what were offered previously. This is specifically after the change in regulations by the IRDAI in 2010 where the regulator has capped ULIP charges at 3 per cent of gross yield if the policyholder remains invested up to 10 years and 2.25 per cent if the policyholder continues to invest for more than 10 years. Therefore, now the front load has been reduced which mainly comprises commission by launching online ULIPs. Online ULIPs are more cost-effective plans as the charges are relatively less.
Taxation in ULIPs
Previously ULIPs used to enjoy exempt-exempt-exempt (EEE) tax status wherein you could avail tax deduction up to Rs 1.5 lakhs under Section 80C of Income Tax Act, 1961. Further, there was no taxation on the gains through ULIP and even the maturity amount was tax-free. In short, they were completely tax-free. Hence, from a tax stand point they were tax-efficient. However, in the Union Budget 2021 it was proposed that capital gains from ULIPs would be subject to taxation similar to that of mutual funds. If the ULIP plan is equity-oriented then capital gains post one-year would be considered as Long-Term Capital Gains (LTCG) and would be taxed at the rate of 10 per cent with tax exemption on gains up to Rs 1 lakh.
Whereas, capital gains below one year would be considered as Short-Term Capital Gains (STCG) and would be taxed at the rate of 15 per cent. Similarly, if the ULIP plan is debt-oriented then LTCG (gains post three years of holding) would be taxed at the rate of 20 per cent with indexation benefit. While in the case of STCG (gains with less than three years of holding), it would be added to your income and would be taxed as per your individual tax slab rate. Having said that, this is only applicable where the annual premium or aggregate of all premiums exceeds Rs 2.5 lakhs in any given financial year.
Who Should Invest in ULIPs?
First of all, the person who does not wish to manage insurance and investment separately can consider investing in ULIPs. Moreover, those who have just started with a job and have a modest salary to insure as well as invest can consider ULIP as one of the options. Further, even those who are not disciplined enough when it comes to investing and are looking for higher lock-in investing, specifically equity investing, can consider ULIPs.
However, if you expect that you will get benefits similar to term plans, then that is not right. The mortality charge is quite high in ULIP for the same sum assured as compared to a pure term plan. Therefore, if you are looking purely for higher risk protection, ULIP is not for you. You would be better off buying a term plan and invest the remaining in mutual funds. And from a taxation perspective, aggregate investment in ULIP below Rs 2.5 lakhs per annum is still more tax-efficient as such a setup enjoys the EEE tax status.