Unit Linked Insurance Plans (ULIPs) What, How & Other Questions

Tarun started his career as an IT engineer in 2008. It was during January when his company asked him to submit proof of tax-saving investments. He realised that he was Rs. 50,000-short of his Sec 80C limit reduce his tax to nil. He got a list of investment options from his colleagues, who had already gone through the same question a few days ago.

Most of these investments options he found were fixed return options with lock-in periods of five years or more. Few of these investments had equity options as well. The one investment which caught his interest was unit-linked insurance plans (ULIPs), and here’s what Tarun discovered about it.

What is Unit Linked Insurance Plan (ULIP)?

ULIP is insurance cum investment plan where you can choose to invest in your preferred fund option or a mix of them. You also have a life cover under this plan, which can be 10 to 15 times your annual premium.

You can invest the premium into unit-linked funds of different securities like equity shares, corporate bonds, government securities, etc. It acts as a dual product which provides life cover as well as helps in creating wealth in the long-term.

Apart from tax saving, investment options and life cover, ULIPs offer many features which make investing easy. ULIP plans can also help your family achieve their financial goals safely, even in case of your unfortunate demise.

How does a ULIP Work?

While purchasing a ULIP plan, you need to choose an investment term, your annual investment amount and tenure of investment. Based on this information and your current age ULIP will assign a life cover to you.

You can allocate your investment to one or more of the multiple unit-linked funds within a single ULIP plan. Few ULIPs also offer many dynamic fund allocation strategies to allocate your money to these funds depending on the market conditions.

Type of Unit Linked Funds in ULIPs

ULIP plans usually provide the following investment avenues. You should choose one or a mix of these funds based on your risk appetite for investment:

• Equity growth fund (high-volatility-high-return)
• Long-term debt securities fund (low-volatility-low-return)
• Liquid fund (little-volatility-low-return)
• Balanced Fund (a dynamic combination of debt and equity securities) (medium volatility)

ULIPs may also offer more than one fund option under each category. You can allocate your entire premium into any one of these funds or you can allocate part of the premium to multiple funds.

You can also choose one of the dynamic fund allocation strategies provided within the fund. In the case of dynamic asset allocation strategy, your total fund allocation between funds changes automatically based on market performance.

Death Benefit in ULIP Plans

The life cover you get when investing in a ULIP plan covers the risk of your early demise. But death benefit is not based on simply the life cover. Instead, it is higher of the following three:

1. Original life cover amount at the start of the investment
2. 105% of the total invested premiums
3. Fund value at the time of death claim

So, for example, if your life cover was 15 times of the annual premium and your annual premium was Rs. 1 lakh, your family will receive the following amounts at your death within policy tenure:

Goal Protection In ULIP Plans

Being a life insurance plan, ULIPs offer a few unique benefits to investors. One of these benefits is the goal protection benefit in case of your early demise.

For example, you start investing in a ULIP plan to achieve your goal of collecting Rs. 1 crore in the next 20 years. You have opted for the goal protection option and will invest Rs. 2 lakhs every year for the next 20 years. Your base life cover in the plan is Rs. 20 lakhs (10 times of your annual premium).

Unfortunately, you meet an early demise. The ULIP plan with goal protection option you have been investing into will give your family Rs. 20 lakhs immediately. But the plan doesn’t end with this payment.

The life insurance company will keep investing Rs. 2 lakhs every year until the maturity of the plan and will pay the fund value at maturity to your family.

Goal protection option is quite useful if you are saving for your child’s higher education or marriage. This option will ensure that your child has adequate funds to complete his/her important life goals, even if you are not there to ensure it.

Maturity Benefit in ULIPs

Every time you invest in a ULIP your money flows into the selected unit-linked funds within the plan. With each investment, you receive more units in the fund. Each unit-linked fund in the ULIP has a Net Asset Value (NAV) that is declared daily.

The NAV changes based on fund performance. These units when are multiplied by the fund’s NAV make the Fund value. On maturity, you receive the total fund value.

For example, your maturity value would be as shown below based on the unit balance in your unit-linked funds at the time of maturity:

Fund	Unit Balance at Maturity	NAV at Maturity	Fund Value
Equity Growth Fund	57,000	115	65,55,000
Long-term Debt Fund	41,000	76	31,16,000
Liquid Fund	21,000	35	7,35,000
Total Fund Value at Maturity			1,04,06,000

Expenses in ULIP Plans

ULIP plans have a few inbuilt expenses based on fund value and associated life cover amount. Following expenses may apply to your ULIP investment:

Premium Allocation Charge	This is an upfront charge which is deducted as a fixed percentage of the premium. This is usually higher in the initial year of the policy. This may vary depending upon the frequency of payment, amount and mode of payment. The best ULIP plans do not apply premium allocation charge on invested money
Policy Administration Charge	These are charged by the insurer for the administration of the policy. It is charged by deducting the units from the total accumulated funds and is fixed throughout the term of the policy. The best ULIP plans may have nil policy admin charge
Fund Management Charge	It is the kind of fees charged by the company to manage the funds. This is charged on the daily average fund value in your ULIP plan. The NAV declared in the ULIP plan is net of FMC charges. The Fund management charges are higher in the equity fund and lower in the debt funds.
Mortality Charge	This charge is for the insurance cover provided in the plan. It depends upon the age and life cover opted by the customer. These are charged on monthly basis and will be deducted from the fund value. Mortality charges apply on the balance amount (Base life cover – Fund Value), which is also known as ‘sum at risk’. So, when your fund value exceeds the base life cover amount, your policy’s mortality charge would be zero. However, this may not apply to your ULIP plan if you opt for goal protection option. With goal protection option, your sum at risk stays the same throughout the policy tenure. Thus, your mortality charge will keep increasing with your age.

There are few other charges like switching charges, withdrawal charges, premium discontinuance charge, premium redirection charge, as well. But these are optional and very few insurers apply them to their ULIP plans now.

Features of ULIP

• Life Insurance Cover: Since ULIP is an insurance plan, it provides financial security to the family in case of the untimely death of the policyholder. A very small portion of the premium is used to provide life cover and rest is invested in the chosen portfolio.

• Tax Benefit: Investing in ULIPs reduces your taxable income under Sec 80C up to Rs. 1.5 Lakh. You can also ensure a tax-free maturity value under sec 10(10D). All you need is to ensure that your annual premiums into the ULIP investment remain below 10% of the base life cover.

For example, if your base life cove in the plan is Rs. 10 lakhs, you should only deposit a maximum of Rs. 1 lakh in any investment year.

• Goal Protection Option: ULIPs not only provide a long-term investment plan for financial goals, but it can also help you in ensuring the goal for the family. Goal protection benefit in ULIPs enables the family to receive intended maturity value from the policy even after your early death.

• Switching Between Funds: You can move your accumulated funds in the ULIP plan from one unit-linked fund to another anytime during the policy tenure. For example, you can move your equity corpus gradually over a year to liquid funds and vice versa. These switches within the ULIP plan does not affect your tax liability.

• The Flexibility of Payment Term: Premium payment term is the tenure in years for which you will keep investing money into the plan, while policy term is the number of years you intend to continue the plan. Your premium payment term can be lower than the policy term.

For example, if you are 45 years of age and want to receive maturity value from your ULIP at the age of 75, you can limit your premium payment tenure to 15 years instead of 30. This will allow you to stop investing at retirement and continue your policy for another 15 years before maturity.

• Top-up Facility: During the policy term, other than the regular premium the policyholder can invest any additional amount into the fund. After deduction of charges, this will be added into the portfolio. One can also avail tax benefit on these top-ups. But remember to not exceed the 10% limit with top-ups. If you do, your investment will not be eligible for tax-exemption under section 80C or 10(10D).

• Payment Frequency: From 2^nd policy year you can pay the premium in any mode. It can be yearly, half-yearly, quarterly or even monthly. However, you should remember that charges are higher in the monthly mode than the yearly mode.

• Payment mode: You can pay the premium either through online mode i.e. through net banking, credit card and debit card or through offline mode i.e. through cheque or Demand Draft. Cash payment is strictly prohibited.

• Liquidity: In case of any emergency, you can withdraw a partial amount or can surrender the policy without paying any charges after 5 years. One can also opt for the loan against the accumulated fund.

What is The Lock-in Period in ULIPs?

ULIPs have a compulsory lock-in period of 5 years. During this period, you cannot withdraw funds from the policy. However, after 5 years you can choose to stop premium payment and withdraw funds partially or fully. In such a case, the company will return the fund after deducting discontinuation charge or surrender charge if any.

One can even stop premium payment during the lock-in period but cannot withdraw the funds until the end of 5 years. In case of surrender, you will receive only a savings rate of interest on your invested money.

Up till 2010, the lock-in period in ULIPs was only 3 years.

What are the Differences Between ULIP & Mutual Fund?

While ULIP act as a dual product providing life cover and investment opportunity, Mutual fund is a pure investment product. The table below shows a comparison between the two:

	ULIP	Mutual fund
Category	ULIP is an insurance cum investment product	MF is a pure investment product.
Liquidity	ULIP has a mandatory lock-in period of 5 years. Post that the fund value is available for partial withdrawal or surrender	Apart from ELSS scheme (lock-in period 3 years) and fixed maturity plans (FMPs), all the other schemes allow withdrawal without lock-in period
Taxation	So far as annual premium invested in the plan is 10% or below of base life cover amount, the investment is eligible for tax exemption under Sec 80C and maturity value is tax-free under Sec 10(10D)	Amount invested in ELSS scheme is eligible for tax exemption under Sec. 80C. The redemption amount is subject to Long Term Capital Gain Tax of 10% if the gain amount exceeds Rs. 1 Lakh
Charges	Two most prominent charges are mortality and fund management charge. Most ULIPs expense ratios fall within the average range of similar investments in the market, including mutual funds.	There are no upfront charges in MF, however, fund management charges are applied and are adjusted from NAV on daily basis. Also, exit load is applicable on few schemes if redeemed earlier than specified period.
Switching	In ULIP, you can switch fund from equity to debt or vice versa at any time. There are no charges or tax.	In MF also an investor can any time switch fund from equity to debt or vice versa. However, it is treated as redemption and hence the capital gain tax is applicable.
Product Usability	ULIP can be only be used for 5 years and above. It is not useful if the goal is of short-term.	Investment in MF can be done even for a single day or for a long-term of 10 years. There are different schemes available for different goals.

What is the Difference Between ULIPs & Traditional Life Insurance Plan?

Traditional Life Insurance plan includes Endowment plan, Money Back Plan, etc. Here’s how ULIPs differ from these plans:

	ULIP	Traditional Plans
Category	It is insurance cum investment plan which provides life cover and investment opportunity in equity.	These are insurance cum saving plan which provide life cover and minimum return over premium paid over the years.
Liquidity	It is highly liquid once the lock-in period of 5 years is over. The amount withdrawn is subject to surrender charge if any.	Surrender or partial withdrawal is not allowed before 3 years in a traditional plan. Even after this period, only a few policies allow partial withdrawal and surrender charges are as high as 50% of the premium paid.
Taxation	Tax exemption under Sec 80c and Sec 10 (10D) is allowed.	Tax exemption under Sec 80c and Sec 10 (10D) is allowed.
Charges	Many types of charges are imposed on premium payment and Fund value throughout the year in ULIP.	Only mortality charges are imposed on the premium.
When to buy?	If you can take the risk and want a good return with life cover can invest in this product.	If you want guaranteed returns with life cover can buy this product
Product Usability	Can only be used for a period of above 5 Years. For better result policy should be continued till maturity.	Will only give benefit if it is kept till maturity.

How to select the best ULIP?

There are many ULIP available in the market which claims to be the best for investment. However, one should keep the following points in mind before finalizing the plan:

1. Low Charges: The best ULIP plans have minimal recurring charges
2. Asset Allocation Strategies: These strategies allow you to safeguard your returns from the equity fund and keep your funds safe while approaching maturity.
3. Switch Options: Unlimited switches should be allowed within a year and that too without any charges.
4. Invest Online: Online investment is far more convenient and easier to manage. You can also look for electronic insurance account to manage all your insurance plans at one place.
5. Goal Protection Option: If you are saving for your child’s financial goals, goal protection protects their goal from your unfortunate death.

References:

1. ULIP Guidelines – IRDAI
2. ULIP Policy Document – SBI Life
3. ULIP Policy Document – Canara HSBC Life
4. ULIP Policy Document – Max Life Insurance