Among the various life insurance products, ULIP or Unit Linked Insurance Plan is a unique product that offers you with life risk cover along with investment opportunities that give you handsome returns in the long run. ULIP was first launched in India in the year 2001 when the Government opened up the insurance sector for direct foreign investment.
Subsequently, the rules governing ULIP was framed by IRDAI, and in 2005, many insurers made their foray into this segment offering their clients a plethora of ULIP products. You must gain insight into what is ULIP so that you can make an informed choice while purchasing in harmony with your requirements.
What Is ULIP?
To understand what ULIP is and how ULIPs work, we need to have an idea about ULIP mechanism in the first place. In order to help you create wealth, the insurance provider allocates a part of your premium to cover for life risk and the rest is directed towards market-linked instruments with an aim to provide you with ample returns to fulfill your long term financial projections.
Your financial planning strategy could be achieving goals for your retirement, children’s education, marriage or other life milestones like purchasing a house. The market-linked returns being higher also entails a certain amount of risk. To temper the risk element, you are in a position to choose a mix of instruments to safeguard your funds. The services provided comes with certain charges being levied by the provider which makes long investment intent imperative to help you reap tangible benefits.
Benefits Of ULIP
As an important tool in your financial planning, ULIP can help you create wealth while enjoying the advantage of life cover, thus protecting your family from financial ruin in your absence. The key benefits accrued to you through a ULIP policy is:
- Life Insurance: The primary reason to purchase a ULIP is to ensure a life cover that protects your family in the unfortunate event of your demise. Since it also provides for investment opportunities, your family is adequately protected in your absence through higher returns.
- Achieve Long Term Goals: The investment feature of ULIP helps in your wealth creation through higher returns earned through market-linked instruments, notwithstanding the risks involved. It is therefore in your best interest to stay invested in the long term to achieve your financial goals and important milestones in life. ULIP in the long term ensures the advantage of compounding to build a robust wealth to match your goals. In any case, ULIP policies come with a feature of lock-in for 5 years.
- Flexibility: The performance of market instruments are heavily influenced by its volatility. Depending on your risk appetite and market movements, you are free to switch your investment portfolio in sync with your needs and appetite. Many insurance providers permit a number of free switches in a year, exceeding which a charge may be levied.
- Income Tax Exemption: You enjoy the dual benefit of tax exemptions when you buy a ULIP. The premium paid during a financial year is exempted under Section 80C for a maximum of Rs.1.5 lakhs and under Section 10 (10D) of the Income Tax Act, 1961 the receipt of death and maturity benefits are exempt.
Types Of ULIPs
The classification of ULIPs is based on some broad parameters, of which the most important is on the investment in the category of funds:
- Fund Investment:
- Equity Fund: The investments are made in Stocks or Equities to earn the highest returns. Obviously, the risk is highest in such fund allocation.
- Debt Fund: Investments are made in fixed income government securities such as treasury bills and bonds which carry a lower risk element. The returns are also lower in such allocations.
- Balanced Fund: In this case, the investments are directed towards a mix of Equity and Debt Funds, thereby tempering the element of risk. You are able to moderate your risk appetite through such allocation.
- End use of Funds:
- Retirement Plans: Here you direct the portfolio through investments that assure you with a comfortable retired life.
- Child Plans: You strategize in such a way that you are able to meet the milestones pertaining to your children like education, marriage etc.
- Corpus Creation: The investments are managed with a long term goal of wealth creation. This is aimed to build a hefty corpus to cater to your future needs.
- Death Benefit:
- Type I: The death benefit paid to the nominee in the event of your demise is higher of the two – sum assured or fund value.
- Type II: In this case, the death benefit paid to the nominee comprises of the sum assured plus the fund value.
ULIP products have the feature of charges imposed upon by the insurers. This was an inhibiting factor for the growth of ULIPs. To moderate the effect of charges on the policyholders, IRDAI has recently mandated that for maturity periods of less or equal to 10 years, the overall RIY (Reduction in Yield) due to charges shall not exceed 3% and for maturity of over 10 years, it is capped at 2.25%. The different charges levied by ULIPs are:
- Premium Allocation Charge: This charge is deducted upfront and your premium in the initial years of the policy is greatly consumed by the components of this charge.
- Mortality Charge: The life insurance cover is taken care of by the monthly deduction of this charge from your premium. The quantum of the charge is influenced by your age, sum assured and the policy term.
- Fund Management Charge: The insurer recovers this charge for the management of various fund allocations. It is applied before arriving at the NAV of the units. However, it has been capped at 1.35% of the fund value per annum.
- Partial Withdrawal Charges: This is levied only when the partial withdrawal takes place. Some insurers allow a few free withdrawals.
- Switching Charges: You have to pay for switching funds between investments if free allowance is exceeded.
- Policy Administration Charges: It is a monthly charge levied for maintaining your policy as the name suggests.
Factors Influencing ULIP Purchase
The important points to remember before investing in ULIPs are:
- Understand what is ULIP
- Personal financial goal
- Comparison of different ULIP offers.
- Risk appetite.
- Investment term horizon.
The popularity of ULIPs has been revived after capping of charges by the IRDAI, which has put it in an advantage of Mutual Funds. Additionally, the life risk cover along with income tax benefits makes ULIPs a robust investment option.