Table of Contents
Introduction to Insurance and ULIPs
Insurance policies are crucial in mitigating financial risks and providing security in an uncertain world. Insurance policies protect individuals, families, and businesses from potential financial setbacks due to unforeseen events such as accidents, illnesses, or the loss of life and property.
They are a legal contract between an insurance company and the insured. The insured person must pay agreed premiums, and the Insurer must compensate the insured or his family when specific pre-defined unforeseen events happen.
Among the myriad insurance products available, Unit Linked Insurance Plans (ULIPs) shine out as a unique hybrid instrument, clubbing the benefits of both insurance and investment.
ULIPs offer life coverage and an opportunity for policyholders to invest in various funds, including equities and debt, allowing them to participate in the financial markets.
This distinctive feature sets ULIPs apart from traditional insurance policies and adds a wealth-building dimension to the protection they afford.
What are Unit Linked Insurance Policies?
Unit Linked Insurance Policies, commonly known as ULIPs, represent a dynamic and innovative approach to insurance and investment. At its core, a ULIP is a unique financial product that combines the elements of life insurance coverage with investment opportunities. It works on the premise of blending insurance with investment.
How ULIPs Differ from Traditional Insurance Policies?
ULIPs stand apart from traditional insurance policies primarily in their structure and functionality, unlike conventional plans, which focus solely on providing a predetermined sum assured in case of an unfortunate event.
ULIPs require policyholders to pay periodic premiums, with a portion of the amount going towards life coverage and the rest invested in market-linked funds. This unique nature distinguishes ULIPs from traditional insurance policies, offering individuals a comprehensive financial solution to meet their needs in different situations.
Dual Benefits: Insurance and Investment:
One of the critical attractions of ULIPs lies in their ability to offer dual benefits – a robust life insurance cover coupled with an investment avenue. In the case of ULIPs, insurance companies divide premium payments into two components: one to secure life insurance coverage that provides financial protection to the policy’s beneficiary in case of an unfortunate event, and another gets invested in the equity market for wealth creation.
ULIPs introduce an element of flexibility and choice. Policyholders can allocate the investment component of their premiums among different fund options, allowing them to tailor their investment strategy according to risk appetite and financial goals. They can also switch between various funds within a ULIP to align their investment with market realities. The transparency and control offered by ULIPs mark a departure from the fixed-benefit plans of traditional insurance.
ULIPS are Extremely Tax-Efficient
Unit Linked Insurance Plans (ULIPs) in India offer significant tax benefits, making them a lucrative investment avenue for individuals seeking to build wealth while ensuring financial security. One notable advantage of ULIP in the Indian context is the tax-free maturity benefit under Section 10 (10D) of the Indian Income Tax Act. According to this provision, the proceeds received by the policyholder upon the maturity of the ULIP are exempt from income tax, which implies that any gains or returns generated over the policy tenure remain tax-free, substantially boosting the investor’s overall returns.
This feature makes ULIPs appealing to long-term investors, encouraging disciplined and sustained commitment to premium payments over an extended period, typically 15 to 30 years.
The extended commitment to premium payments fosters disciplined investment behavior and accumulates considerable tax-free wealth for investors.
In addition, under the Indian income tax laws, an investor can also avail of a deduction in tax under section 80C of the Income Tax Act if they choose to invest in a ULIP, provided their current limit of Rs. 150000 per year is pending and not claimed in some other permitted investment category.
Though mutual funds offer immense benefits to investors, this tax-free maturity of ULIPS gives them an edge over mutual funds, thus giving investors a significant reason to add them to their overall investment portfolio.
Essential Conditions To Avail Tax Advantage of ULIPs
To claim maturity tax exemption under section 10 (10d), a ULIP must offer at least ten times the insurance coverage of the annual premium.
Secondly, India’s Income Tax Act amendment states that ULIPs issued after February 1, 2021, with a yearly premium of more than Rs. 2 lakh 50 thousand, will not qualify for tax exemption under section 10(10d) of the Income Tax Act.
The investors will be liable to pay long-term capital gain tax (LTCG) or short-term capital gain tax (STCG) based on the duration of ULIP investment, much like mutual funds or equity investments.
Finally, there is a locking period of 5 years from the inception date of a ULIP to avail of any tax benefit, including 80c under the Income Tax Act of India.
Fund Switching Option in ULIPs – A Game Changer!
The fund-switching option in Unit Linked Insurance Plans (ULIPs) gives investors a dynamic tool to optimize their investment portfolio according to market conditions and individual risk preferences. ULIPs allow policyholders to allocate their premiums and existing fund corpus into various predetermined funds, such as equity, debt, or a combination.
The Fund Switching feature enables investors to move their funds seamlessly between these different investment avenues, offering flexibility that traditional insurance or investment products may lack.
One of the key advantages of the fund-switching option is its ability to help investors maximize returns and mitigate risks in a changing market environment. For instance, during bullish market phases, investors may switch their funds to equity-based options to capitalize on potential capital appreciation. Conversely, they can switch to debt or secure funds in bearish market conditions to protect them from potential downturns. This flexibility allows policyholders to adapt their investment strategy based on market trends and risk tolerance, enhancing the overall wealth-building potential of the ULIP.
New Age ULIPs Offer Cost-Efficient Switches
In earlier first and second-generation ULIPs, fund switching was not free beyond a point, and companies used to charge a hefty fee per switch beyond a certain number of switches in a policy year. In contrast to earlier ULIPs, modern ULIPs have evolved to offer more investor-friendly features.
New-age ULIPs typically provide a free fund-switching option without any upper cap or comparatively lower fund-switching charges beyond a certain number of switches in a policy year, thus allowing investors to reallocate their investments without incurring additional charges.
This enhanced flexibility aligns with the growing demand for customer-centric financial products and empowers investors to make strategic decisions without being hindered by excessive fees. Overall, the fund-switching option in ULIPs is a powerful tool for investors to navigate the complexities of the financial markets while optimizing their wealth accumulation and protection goals.
Essential Charges in ULIPs
In Unit Linked Insurance Plans (ULIPs), essential charges are fundamental in determining the overall cost and performance of the policy. Let us look at some of the vital charges levied on all ULIPs.
Mortality Charges
Insurance companies levy mortality charges to cover the risk involved in providing life insurance coverage. These charges typically increase with age due to higher mortality risk but decrease with increasing fund value as the insurance company’s risk diminishes with a larger pool of funds. Typically, for a person in the 35 to 40 age band. Mortality charges become nil in 8 to 10 years as the corpus of funds outgrows the Insurance company’s risk.
Fund Management Charges
These charges are akin to those levied in mutual funds and vary depending on the fund type (debt or equity). For instance, equity funds generally incur higher management fees due to active portfolio management and higher risk-reward ratios. Conversely, debt funds usually have lower management charges in tune with the lower risk and potential gains. Balanced fund charges typically lie between equity and debt funds, corresponding to their balanced portfolio.
Policy Administration Charges
Policy administration charges cover the administrative expenses incurred by an insurer in managing the policy. Over time, these charges have decreased substantially in new-age ULIPs due to the revolution in technology and the advent of fintech companies, and some ULIPs have waived them entirely, making the policy more cost-effective for investors.
Redundant Charges of earlier ULIPs
In the earlier iterations of Unit Linked Insurance Plans (ULIPs), redundant charges were a significant concern, tarnishing their reputation among investors. Various charges in the first and second-generation ULIPs eroded potential returns. One such fee was premium allocation charges, which were deducted upfront from the premium paid by the policyholder, thus reducing the amount invested in the chosen funds.
Partial withdrawal charges imposed penalties on policyholders wishing to withdraw a portion of their funds before the lock-in period, reducing their investment flexibility.
If a policyholder discontinues their policy prematurely, the insurance company may levy discontinuation charges, which could result in a substantial loss of the invested capital.
Surrender charges further compounded the issue by imposing penalties on policyholders surrendering their policies before the specified duration.
These charges collectively undermined the attractiveness of ULIPs as an investment option, significantly reducing the potential returns. Investors often felt trapped by these charges, limiting their ability to make educated financial decisions and access their funds when needed. Consequently, first and second-generation ULIPs gained a negative reputation in the market, with many investors viewing them as costly and inflexible products.
New Age ULIPs Are Free of Redundant Charges
With the evolution of the insurance industry, new-generation ULIPs have addressed these concerns related to redundant charges by shelving them and adopting a more transparent fee structure. Many modern ULIPs have minimized or eliminated premium allocation charges, which ensures that they invest a higher percentage of the premium in the funds chosen by policyholders. They have significantly reduced or removed partial withdrawal charges, which grants policyholders greater flexibility to access their funds as needed. Many new ULIPs have revised discontinuation charges, offering more favorable terms for policy surrender or discontinuation. They have made surrender charges more transparent and fair, aligning them with the policy’s duration and gradually decreasing over time.
Overall, eliminating or reducing redundant charges in new-generation ULIPs has made them a more competitive and prudent investment option for individuals seeking insurance coverage and investment opportunities. By offering greater transparency, flexibility, and potential for higher returns, these modern ULIPs have regained investor confidence and positioned themselves as valuable financial instruments in the market.
Child Variant of ULIPs is a Useful Product
The child plan variant of Unit Linked Insurance Plans (ULIPs) presents a valuable financial instrument for parents seeking to secure their child’s future.
Like all ULIPs, the child variant also offers a dual benefit of decent insurance coverage and corpus building, albeit with a slight difference; here, the insured party is a parent, and the beneficiary is the child, thus making it an attractive option for long-term financial planning for children.
One of the key advantages of a child plan ULIP is its ability to build a corpus for a child over time through systematic investment. The investment component of the plan allows for potential growth, helping parents accumulate a reasonable amount of funds to meet their child’s future financial requirements.
Moreover, the flexibility offered by ULIPs will enable parents to choose from various investment options based on their risk appetite and financial goals, allowing them to tailor the plan according to their specific needs and preferences.
What makes the child variant of ULIPs a powerful tool is the provision that in the unfortunate event of the insured parent’s demise during the policy term, the child’s future financial needs remain protected, as child ULIPs keep paying the premium payment for the remaining time of policy from their side till the maturity date of the policy.
The accumulated corpus ensures that the child’s education expenses or other life goals, such as marriage, are not compromised due to unforeseen circumstances.
The insurance coverage provided by the child plan ULIP offers peace of mind to parents, knowing that their child’s financial future is protected regardless of unforeseen events. The death benefit ensures that even in the absence of the insured parent, the child’s needs are taken care of, safeguarding their aspirations and providing a secure foundation for their future endeavors.
Overall, the child plan variant of ULIP emerges as a valuable tool for parents looking to secure their child’s financial well-being and provide for their future needs.
Conclusion: Unit Linked Insurance Plans (ULIPs) are worth considering!
In this article, I have decluttered the complexities of ULIPs and made a case for considering them as a part of an overall financial plan.
It is evident from the discussion so far that ULIPs, distinguished by their dual nature of insurance and investment, emerge as a versatile solution for individuals seeking decent insurance coverage and wealth accumulation through a single product.
Unlike traditional insurance policies, ULIPs empower policyholders with the maneuverability to customize their investment strategies according to their risk appetite and financial goals, thus providing a personalized approach to wealth management.
The standout advantage of ULIPs lies in their tax efficiency, making them an exciting option for aware and savvy investors. By leveraging the tax benefits associated with ULIPs, individuals can optimize their investment returns while securing their financial future.
Moreover, the evolution of ULIPs has significantly reduced redundant charges, enhancing transparency and ensuring that investors maximize their returns effectively.
Furthermore, introducing innovative variants like the child plan and ULIP underscores the adaptability and relevance of this financial product in addressing diverse life goals and needs. Whether it’s safeguarding a child’s future or planning for retirement, ULIPs offer a comprehensive solution that aligns with the evolving priorities of individuals and families.
Finally, it is safe to conclude that among the plethora of financial products, ULIPs shine as a unique yet dynamic financial instrument that empowers individuals to secure their financial well-being while realizing their long-term aspirations.
Kartikay Ungrish is the Founder-director of Worthy Education Academy & Worthy Financial Services. He is a UGC NET-qualified Assistant Professor of Management, A MBA, a licenced mutual fund distributor, and a financial advisor. He helps people build wealth through prudent investments in mutual funds and other financial products. Start by creating your free wealth management account with him as your financial advisor. Contact for more details.
