Unit linked insurance plans or ULIPs as they’re referred to, are a combination of investment and insurance. Policyholders have to pay a premium either monthly, semi-annually or annually for a term of between 5-15 years. After a small portion of the premium is deducted for policy administration, fund management and allocation charges, the rest of it goes towards life insurance and investment in mutual funds, bonds or stocks.
When it comes to investments, policyholders can either opt for high-risk funds that provide more exposure to equity, or debt-oriented funds that are relatively risk-free. Like in the case of mutual funds, the premiums are pooled together to form a unit fund, where units are allotted to investors and a net asset value (NAV) is declared, which changes daily on the basis of the performance of the fund.
Since the value of ULIPs is based on market conditions, one question that comes to mind is whether they are actually a boon or a bane. Let us consider some of the main advantages and disadvantages provided by ULIPs to evaluate whether they are worth investing in –
Returns are subject to market fluctuations
Combination of investment and insurance
Expensive and complex
5 year lock-in
Partial withdrawals allowed
Higher costs in initial phase
Advantages OF ULIPs
Good returns: ULIPs can offer good returns depending on the fund one has invested in. If the fund is heavily invested in capital markets, then if the stock markets do well, then the fund will also do well.
Insurance cover:Since ULIPs provide a mortality cover, they work as a safeguard in case the policyholder should die unexpectedly, as the nominees can make a claim for the sum assured.
Flexibility: ULIPs provide the investor the option of switching between investment funds, to suit their changing goals and needs. Policyholders can take advantage of the movement of prices of stocks and switch between options like equity, debt or cash. They can also opt for programmed switches every month if they are not familiar with how to actively monitor their funds, where a fixed amount is switched at a specific date.
Good long-term investment: ULIPs are an ideal investment option for those who would like to invest money from a long-term perspective. This is because market fluctuations tend to provide lower returns in the short run, but long-term market investments tend to yield very attractive returns. They are ideal for those who would like to invest in a long-term goal-oriented savings instrument, like their child’s education or marriage.
Tax-free returns: ULIPs provide tax-free returns and tax benefits as well. Tax deductions are provided under section 80C of the Income Tax Act for premiums paid towards ULIPs. Furthermore, the death benefits paid under ULIPs are also completely tax free. The policyholder also has the assured benefit or the value of the investments made towards the fund – whichever is higher and these returns are not taxable either.
Partial withdrawals: Policyholders are also entitled to partial withdrawals on after the lock-in period provided that they are no more than 20% of the fund value of the policy. These withdrawals are completely tax free as well.
Top-ups:Investors can also invest excess money through period top-ups provided by ULIPs. These top-ups are also eligible for tax deductions as well as tax exemptions provided that the premium does not exceed 10% of the sum assured.
Disadvantages Of ULIPs
Expensive and Complex: Since ULIPs combine insurance with investment, the premiums charged for the life cover turn out to be far more expensive than term insurance. They are also complex in terms of charges and not very transparent as it is not clear how much of the money goes towards insurance, management expenses and investment. Thus, it is not viable to make redemptions at the end of the lock-in period as the fund value might be low at the time due to higher initial charges.
Higher costs in initial phase: ULIPs cost more in the initial years because of the charges levied on the investor, that go towards policy charges.
Market fluctuations:Due to market fluctuations, a lower amount of returns are generally anticipated in the initial years. So if you are looking at investing on a short-term basis, then ULIPs are not your best bet.
Switches are chargeable beyond a point: Most insurers provide free switches up to a certain number and thereafter, switches are chargeable for each transaction.
Lock-in period: ULIPs have a 5 year lock-in period, during which time, withdrawals cannot be made.
In conclusion –
There are various advantages and disadvantages associated with ULIPs. For those who prefer to invest in those instruments that provide a range of benefits under one roof – those being good returns, tax savings and life cover in such a case – ULIPs prove to be a good option.
However, it is usually recommended that investments and insurance be kept separate as the role played by both is very different.
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