We humans always try to multitask in all parts of our lives. And we also try to multitask on insurance and investment through ULIP.
But is it efficient? Are ULIPs successful in giving you the best life insurance coverage and returns on your investment? Let’s discuss.
Estimated read time: 4 minutes and 23 seconds
Buckle up, here we go!
What is ULIP?
A Unit Linked Insurance Plan (ULIP) is a mix of investment and life insurance. This financial product promises to provide life cover during the policy period and generate good tax-exempt returns at the end of the policy period.
As insurance is a part of the product, you can claim a tax deduction under Section 80C on premiums paid every year. Also, the returns received at the maturity of the policy are tax-free if the annual premium you pay is below ₹2.5 lakhs per year.
On average, most ULIPs have a lock-in period of 5 years. After that, you can make a partial withdrawal with or without a penalty based on the policy.
How does ULIP work?
As ULIP is a combination of two products – insurance and investment. Let’s break them up and understand them separately.
1. The insurance part of ULIP
A ULIP provides 10 times the premium paid as insurance cover. So, if you pay an annual premium, of ₹1 lakh, in case you were to die, the nominee would get ₹10 lakhs.
Remember, they provide this coverage only during the lifetime of the policy. And provide no insurance coverage after the policy matures.
If you survive the policy period, you will get the amount of premium paid plus the returns generated.
As any insurance plan collects a premium to cover your life and health, ULIPs also allocate a portion of the premium towards insurance.
Let’s say if you pay an annual premium of ₹1 lakh, the company allocates around ₹5k towards insurance coverage. They collect these charges in the name of mortality charges, premium allocation charges, policy admin charges, etc.
And I wouldn’t have to tell you that if you buy ULIP after the age of 40, they will allocate a huge portion of the premium towards insurance and set aside less for investments.
2. The investment part of ULIP:
After deducting some portion of the premium for insurance coverage, the company allocates the rest for investments in the market. For simplicity, let’s say they set aside 95% of the premium towards investments.
For investment, you can select to invest in various fund options like equity, debt, or hybrid. Also, you can choose if you want to focus your investments on a large cap category or a small cap.
Even after buying the ULIP, you can switch your investments between the fund options provided by the company.
To provide this service, just like other mutual fund companies, they charge you fund management charges. The maximum charge allowed is 1.35% per annum, which is higher than most index funds.
I hope you have understood the basics of ULIPs. Now, let’s talk about the drawbacks and benefits of ULIPs.
Drawback of ULIP
1. Low insurance coverage
A ULIP provides 10 times the premium paid as insurance cover. And as we discussed that returns from a policy with a premium of above ₹2.5 lakhs won’t be tax-free. So, most people won’t select a plan above that amount.
That means you will be receiving a life insurance cover below ₹25 lakhs, which is very low in today’s world of high inflation.
So, stick with term insurance for life. You will get a better life cover with a term plan.
2. High charges
Before 2010, there was low transparency in ULIP products and the companies used to charge high fees. Most of the initial year’s premium was shared with the agents as commissions.
These days, due to criticism and regulations, we can see more transparency, but the charges are still high. They collect 18% GST on the charges too.
Also, we didn’t discuss the commission paid to the agent from your premiums in the initial year, as we don’t have recent data. But we always recommend it to avoid any middleman.
3. Low return on investments
Most ULIP products have failed to beat the index funds. And after the high management fee, the returns are even lower.
These returns, being tax-free, create an illusion. In general, we have seen that even after paying the tax, you can generate better returns than these. We discussed it here.
4. High lock-in period
5-years lock-in period is too high as even ELSS funds have a lock-in period of just 3 years.
5. Lack of fund house switching option
Let’s say you invest in ULIPs of fund house A. You can switch your investments between the various funds offered by fund house A, but you cannot switch to funds provided by fund house B.
In mutual funds, if you are not happy with the management of one fund house, you can easily redeem your investments and invest in other fund houses.
6. High initial investment
Most ULIPs investment requirement is above ₹50k per year and is collected as a single payment. These days, SIPs are being introduced to ULIPs too.
But if you miss payments, your policy will be deactivated, and you won’t be able to receive your premium amount before the policy matures.
7. Age factor
If you buy ULIP in old age, they will deduct a huge portion of the premium for insurance coverage. Your total investment will be low.
Looking for benefits of ULIP?
Apart from the tax benefits it used to provide, we don’t receive many benefits from ULIPs.
In budget 2021, the government announced the new ₹2.5 lakh premium rule. And most experts predict that slowly ULIPs will be taxed similar to mutual funds.
So, if you want to invest in the market while saving tax, invest in ELSS funds. Long-term capital gains are only taxed at 10% after ₹1 lakh profit every year. This is better than investing in low returns products to save tax. Want to see a calculation of it? Check here.
If you want good life insurance, only buy a term insurance plan. Don’t look for any other insurance plan. We got another calculation to show why. Check here.
So, don’t multitask in life and with your investments.
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