A unit linked insurance plan or a ULIP is a multifaceted insurance product that addresses basic needs and priorities, while providing the dual benefit of insurance and investment. It can switch from equity to a balanced fund and allows withdrawal during emergencies. Thus, a ULIP can be used as a whole life plan, an accumulation and a withdrawal plan (pension and annuity).
The lack of understanding of ULIP benefits along with its myths see many investors surrendering their ULIP plan before it realizes its optimum potential. Here’s what makes ULIPs work and the myths associated with them.
ULIPs to Meet Long-Term Financial Goals
For meeting long-term financial goals, you need an investment tool that has long-term investing as its core principle, which is what a ULIP is. ULIP can help achieve multiple financial goals as it offers customizable options that align with your needs.
To begin with, the insurance component provides peace of mind for investors. ULIPs have in-built reducing balance sum assured, which enables the continuity of your investment and achievement of your goals even in your absence. It is a dynamic concoction of potentially high returns, systematic investment plans (SIP), top-ups, tax benefits, premium waivers, and the flexibility to switch between an asset mix comprising equity or debt using the same policy, among other advantages.
Here, the duration of your goal is more important than the size of your ULIP. The long-term nature of the product insulates it from market volatility ensuring a consistently performing portfolio. This is evidenced by the data of the last five cycles.
To invest in a ULIP, it is imperative to have an in-depth evaluation of your life goals and risk appetite. To understand the diverse and flexible nature of a ULIP, let’s consider three unique situations.
Customer 1: Kavya, a fresh management graduate, has landed her first job. She wants to first insure herself so that her parents are safeguarded. She also seeks investment options that can help build substantial capital in the long term. She chooses a ULIP because it offers both.
Her goal – Protection and wealth creation.
Investment and impact – With a longer investment horizon and higher risk absorbing capacity, Kavya invests in a ULIP leaning towards higher equity participation. The policy’s age-based investment strategy keeps adjusting the portfolio according to her risk appetite. She can switch from higher to moderate equity exposure as required. This allows for a well-balanced portfolio throughout the investment period and facilitates the goal of capital growth.
Customer 2: Kumar, a teacher in his mid-thirties, is the only earning member of his family consisting of his wife and a 6-year-old son.
His goal – Wealth preservation and withdrawal for a specific goal.
Kumar’s major concern is his family’s protection and well-being. He also needs to plan for his child’s higher education, 12 years later. He must ensure enough capital growth for both goals to avoid having to dip into one to fund the other. From the 15th year to the 20th year he can enable the systematic withdrawal plan feature of the ULIP to take care of his monthly expenses. Post withdrawal, he will be left with balance funds that can be directed towards a retirement plan.
Investment and impact – Kumar finds ULIP to be a great tool as it offers insurance and will help him achieve multiple financial goals. He opts for an automatic trigger-based investment strategy, where any appreciation above a target percent level is transferred to the debt fund. This can help him reap the benefits of potential market appreciation while also minimizing the downside risk. In addition, his life insurance cover safeguards his family’s financial future.
Customer 3: Dr. Kapoor is 50 years old and wants to chalk out a legacy plan for his 20-year-old daughter.
His goal – Legacy planning.
Typically, ULIPs offer two types of death benefits structures:
- Type 1 – Death Benefit is higher of Sum Assured on death or Fund value
- Type 2 – Death Benefit is Sum Assured on death plus Fund value
Most ULIP plans in the market offer the structure of Type 1 and it would be prudent of Dr. Kapoor to opt for the same. He will benefit from the mortality charge which would reduce as the fund value grows over the term of the policy. This is because the premium is calculated on the difference between sum assured on death and fund value.
Therefore, a ULIP with INR 50,000 monthly premium bought at 50 years of age would yield the death benefit at approximately INR 60 lakh i.e., 10 times the annual premium. By the time the policy tenure crosses five years, he would have already paid INR 30 lakh as premium.
Additionally, with growth, the fund value could be INR 33 Lakh, which means the company would charge a risk premium on INR 27 lakh (difference between INR 60 lakh, which is sum assured on death at the start of policy and INR 33 Lakh, which is the current fund value). So, over the duration of the policy, the mortality charge would reduce in the ULIP, making it more attractive.
Investment and impact – A ULIP with balanced funds where the death benefit is higher of sum assured on death or fund value as this will help him work out a robust legacy plan.
These three scenarios highlight a few benefits but ULIPs offer countless options as per the investor’s needs. Let’s look at its benefits.
Benefits of ULIPs
There are some incentives that naturally accrue with a long-term investment in ULIPs.
- Insurance Plus Investment: A ULIP offers a safe path to wealth creation with the added benefit of life cover, the two main concerns for most individuals. Additionally, the insurance coverage offers a longer tenure which enhances peace of mind.
- Long-term Holding Loyalty Benefits: Any investment held for a longer period tends to exhibit lower levels of volatility compared to those held for a shorter period. A ULIP’s lock-in period provides the much-needed discipline to stay invested, especially during a volatile market when investors are tempted to cash out. It will reward you for staying dedicated for the longer term by way of loyalty and wealth boosters that will increase the fund value and the maturity corpus.
- Systematic Investment Plan (SIP): A ULIP offers the benefit of a SIP. This reduces the investment amount load with the benefit of average cost. Investing in SIPs over a longer period enables one to generate a wealth-building portfolio.
- Flexibility to Switch Between Funds: ULIPs provide the flexibility to seamlessly switch between funds as per your risk appetite that is likely to change with time and age. The wide variety of investment strategies and options that a ULIP offers provides a varying level of exposure to equity and debt securities. The switch between higher to moderate to low equity participation can be availed without having to exit the policy.
- Premium Waivers: Capital building and life cover apart, some plans offer additional distinctive features. For instance, most child plans offer an inbuilt feature that allows the premium to be waived off in case of the parent’s unfortunate demise, without affecting the plan’s validity.
- Tax Benefits: A policyholder is eligible for tax deduction during all three phases: the investment, earnings, and withdrawal. The premium is eligible for tax deduction under Section 80C. Additionally, partial withdrawals and the maturity amount are exempt from tax. Returns from the policy on maturity are exempt from income tax under Section 10 (10D) of the Income Tax Act subject to certain conditions.
- Protection from Liquidity Crunch: Emergencies are a part of life. However, not everyone possesses sufficient liquid assets and liquidation of long-term assets impacts portfolio returns, not forgetting the tax and other costs associated with it. A ULIP is a lifebuoy at such times as it allows for partial withdrawal from accumulated funds, provided it is after the lock-in period.
- Ease of Additional Investment: Let us consider the reverse scenario of wanting to make an additional investment into your ULIP to bump up your maturity corpus. You can buy a ULIP at a lower premium or top-up later during the tenure of the policy when surplus funds are available. The top-up premiums enjoy the same tax benefits as normal premiums.
- Flexible Premium Paying Modes: ULIPs offer a variety of convenient premium paying modes to help you plan your finances. You can pay your premium(s) through single, limited and regular premiums. Single premium one-time payment only; limited premium yearly, half-yearly, quarterly; monthly regular premium are some options.
Three Myths Related to ULIPs
There are myths that impede the growth of the investor’s corpus and it is imperative to comprehend them.
- Myth 1: ULIP only invests in equity
Equity funds by nature have a higher risk as they offer higher returns. As discussed, the versatility of a ULIP allows you the option to invest in Equity, Debt or Balanced funds based on your goals, lifecycle and risk appetite. The option to switch between funds exists all through the tenure of the policy and at no extra cost.
- Myth 2: The investment amount cannot be increased
A ULIP can be purchased at a lower premium and depending upon the structure of your policy allows for a top-up.
- Myth 3: ULIPs are expensive
The benefits of investing in ULIPs far outweigh the costs associated with it. While there are certain charges, which are a part of the construct, the cost structure for ULIPs is extremely efficient. Typically, the biggest cost of any long-term equity fund-based investment is the fund management charges and for ULIPs, it is capped at 1.35%. Hence, over a long term they will give a better return than mutual funds given the graded fund management charges (FMC) structure of a mutual fund.
The graded FMC structure allows a charge of up to 2.5% when fund size is lower and gradually reduces it to 1.5% as the fund size improves. If we assume no other charge apart from FMC and similar returns from ULIP and mutual fund then this difference results in ULIP fund value beating mutual fund in the year seven or eight.
Bottom Line
ULIPs offer an investment option that can straddle multiple financial needs and goals and cater to the core concern of capital growth and life insurance. This makes a case to include it in your portfolio, especially if growth and protection are your priorities. Just as your smartphone multitasks to make your life easy, a ULIP multitasks to ensure your life goals are fulfilled.
