ULIP (full form is Unit Linked Insurance Plan) is a tax-saving investment option that provides the dual benefits of investment as well as insurance. Though not as popular as other tax-saving instruments like National Pension Scheme (NPS), Equity Linked Savings Scheme (ELSS) and Public Provident Fund (PPF), ULIPs could still be a worthy investment option.
Read this blog to know more about ULIP, its types, benefits, how it works and whether you should invest in one.
The full form of ULIP is Unit Linked Insurance Plan (ULIP). It is a tax-saving investment option that works both as a life insurance plan and investment option.
Though this seems great as an investment option on paper, ULIPs have certain limitations.
Here’s how a ULIP scheme works.
Let’s say you have bought a ULIP scheme. You pay your premiums towards the insurance cover, which is usually capped at 10 times the annual premium amount. A portion of the premium goes towards the insurance portion, while the remaining portion of ULIP is invested towards funds/stocks of your choice.
As per the Insurance Regulatory and Development Authority of India (IRDAI), the lock-in period of ULIP is 5 years. This means you cannot redeem your ULIP investments, that is the principal amount with interest before 5 years.
There are two types of ULIP classified according to the fund types and purpose. These categories are further subdivided. Let’s take a look at the types and subtypes below:
As per your ability to handle investment risk and financial needs, you can choose to allocate a part of your principal amount to the following fund types:
To understand which type of ULIP to choose, you can take note of the different purposes they fulfil. Let’s check them out!
Insurance companies offer the following types of funds under ULIP.
These are investments where you invest in stocks. They are allotted according to their Net Asset Value. As their NAV is directly linked to market fluctuations, stocks under equity funds are highly subjected to market risk.
Hence, investing in equity funds can be highly fruitful or loss making for investors, depending on the market.
These funds invest in fixed-income securities like government bonds and debentures. Debt funds carry lower risks than equity funds. These funds offer low but stable returns and are ideal for risk-averse investors.
Balanced or hybrid funds combine the features of equity and debt funds. This means balanced funds offer a good opportunity for growth while lowering the risks of loss.
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While there are numerous reasons why you should invest in a Unit Linked Insurance Plan, here are some of the crucial advantages that you can enjoy with it:
Depending on which policy type you avail and your insurance company, you have the choice to choose among various life cover amounts. Generally, the minimum cover starts at 10 times your annualised premium.
As mentioned above, depending on your risk appetite and financial goal, ULIP allows you to choose the fund type.
Let’s say you are a risk-averse individual who wishes to only invest in guaranteed returns. In this case, you can invest in debt funds as they are the most suitable for your risk profile.
As per your market understanding, if you feel that another fund will perform better in the future, then you can switch funds.
At any time while holding this policy, you can choose to shift your investment from one fund to another. For example, if you feel that the market is soon going to be unstable, you can switch from equity to debt funds.
With the purpose of wealth creation and management, ULIP could help you generate funds to fulfil your long-term financial goals. With a lock-in period of five years, your initial investment gets compounded, which allows you to reap higher overall returns. With these returns, you can pay for your child’s education expenses, buy a house, or simply enjoy your retirement.
One of the primary benefits of ULIP is that they offer tax deductions and exemptions under Section 80C and 10(10D) of the Income Tax Act, respectively. The former applies to the premium you pay towards ULIP and the latter applies to any returns you obtain upon maturity.
It is beneficial for investors to know the right ways to invest in ULIPs to gain maximum returns.
Investing early ensures a long-term investment horizon which helps bring in better returns. In addition, an early ULIP investment provides a lifelong benefit to your family as life insurance cover.
Similar to the previous point, if you invest in ULIP for a long period, there are chances for maximising returns. Although ULIPs have a lock-in period of 5 years, it has been seen that investors who stay invested for longer get better returns.
Investing regularly also allows the plan to generate better returns. When investing in a ULIP, you need to make sure to continue paying premiums on a regular basis to avoid discontinuance.
Setting up investment goals will help you plan for the big picture. Knowing your current financial goals will help you plan when to invest and for how long.
Also, you can plan your finances in such a way as to leave the invested money untouched for fulfilling recent goals. By doing so, you can comfortably invest a part of your income for long-term ULIP and yield from them.
Under Section 80C of the Income Tax Act, ULIP allows investors a tax deduction of Rs. 1.5 lakh per year. As a result, ULIP can also benefit you as a tax-saving tool. Furthermore, Section 10 of the ITA exempts ULIP maturity benefits from taxation if the total annual premium is below Rs.2.5 lakh.
It is beneficial to keep certain points in mind while choosing the best ULIP plan to get optimal benefits:
Before opting for a particular ULIP plan, you should study the market behaviour closely. This will help you decide which funds will bring you good returns on investment. In addition, this will help you paint a bigger picture about when to switch funds to prevent losses.
For an investor with a dependent family, children’s higher education, marriage and retirement are long-term plans. Early investment in ULIP helps bear the right result to fulfil each of these plans.
Therefore, every investor must necessarily sketch out their goals before choosing a fund to invest in to get the best results.
Knowing their risk-taking capacity assists an investor plan whether they should go for debt funds or equity funds. If they can bear a major loss, investors can try their luck with equity funds, as these funds are highly subjected to market risks.
However, investors who do not want to opt for loss involving a lump sum amount might choose debt funds.
When it comes to investments, you should always ask yourself whether the scheme is aligned with your investment goals. For long-term investments, your portfolio should have a mix of NPS, PPF, equity mutual funds, ELSS, etc. However, ULIP investments could be a difficult choice to fit into your portfolio.
If you’re in your 40s or more, the premiums would be on the higher side and could eat your potential returns. Similarly, if you start investing early, mutual funds investments have the potential to offer better returns in the long run.
Also, the charges associated with ULIP investments are quite high compared to the mutual fund expense ratio, though IRDA has mandated the insurers to limit ULIP charges at 2.25% p.a. Consider all these factors before investing in ULIP.
Though having life insurance plans is a necessity, adding ULIPs to your investment portfolio may not be a good idea due to its complexity and limitations. However, if you are looking at ULIP as an additional tax-saving instrument, you may consider investing in it.
Investment decisions are a personal choice. Consider your investment goal, investment horizon and other factors before investing in ULIP.
Ans: ULIP and mutual funds offer different features and benefits to investors. The former is an investment cum insurance policy, and the latter is purely related to investment. ULIP have a lock-in period, but most mutual funds are open-ended schemes with varying maturity duration. Thus, depending on your financial goal, you can make your decision to opt for either.
Ans: As a part of your premium amount goes towards investing in funds, there is a risk of market fluctuation associated with them. The performance of equity funds is impacted by market volatility, while debt funds are affected during rising interest rates. Thus, your ULIP investment returns are always at risk.
Ans: Yes, like every other investment, you will have to pay an additional fee for ULIP to your insurance company. Some of these charges are premium allocation charges, fund management charges, mortality charges, partial withdrawal charges, etc.
Ans: No, with the guidelines set up by IRDAI, investing in ULIP is not expensive anymore. As per the guidelines, fund management charges for the ULIP cannot be more than 1.35%, and 2.25% can be the maximum total effective charge.
Ans: The portion of your premium investment that goes towards funds varies across insurance companies. However, after deducting all the additional charges, the majority of the balance is kept aside for investment. Thus, a very small percentage goes towards insurance cover.
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Disclaimer: Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.
This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
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