Welcome to the financial journey, where we all make choices that can shape our future. Sometimes, however, we find ourselves at a crossroads, realising that a decision we made might not be the best one.
We are talking about investing in ULIPs (Unit Linked Insurance Plans). If you’re one of those who invested in ULIPs and are having second thoughts, worry not! We are here to guide you through the maze of ULIPs and help you make informed decisions.
Estimated read time: 6 minutes and 54 seconds
Buckle up. Here we go!
What are the problems with ULIP?
ULIPs, often marketed as a one-stop solution for insurance and investment, have their fair share of complexities. The primary reason why many financial experts advise against them is the combination of insurance and investment in a single product.
ULIPs are notorious for their opaque fee structures, which can eat into your returns over time and their low life coverage. Also, most ULIPs failed to beat the returns of index funds.
If you are new to ULIPs, we have discussed what ULIPs are and why they are not a good investment here.
Do you find yourself in a situation where you’ve invested in ULIPs and are second-guessing your decision? The first step is acknowledging the mistake.
Mistakes happen. The key is to learn from them and take corrective action.
Now, if you’ve recognized that investing in ULIPs is a bad idea, let’s explore 3 options available to you.
Note: A free look period is available in ULIPs where you can return the policy if you don’t like it. This period lasts up to 15 days and, in a few cases (online insurers), for 30 days.
Option 1: Discontinuing ULIP investments during the lock-in period
ULIPs have a lock-in period of 5 years. This means you can’t surrender and withdraw your investment money before 5 years. But you can discontinue your investments.
Discontinuing your ULIP investments during the lock-in period comes with certain consequences, like incurring discontinuance fees, lower returns, etc.
Here’s what typically happens if you choose to discontinue your ULIP investments during the lock-in period:
- Discontinuance Charges: ULIPs often impose discontinuance charges if you exit the policy before the lock-in period ends. They deducted these charges from the fund value, reducing the amount you receive upon surrender. The discontinuance charges can be around ₹1,000 to ₹6,000 depending on your premium amount and year of discontinuing. You can check the exact amount in the policy document.
- Termination of Insurance Cover: When you discontinue your ULIP policy, you immediately lose your insurance cover provided by the ULIP. This could leave you without the intended life insurance protection if you haven’t made alternate arrangements. We always recommend buying a term insurance as soon as possible.
- No Allocation to Investment Funds: When you discontinue ULIPs investments, the accumulated fund you invested in earlier will be moved to a discontinuance policy (DP) fund. The insurance company will provide a bare 4% interest (decided by IRDA) on the accumulated funds until the lock-in period ends. Also, they will charge a management fee of 0.5% every year, so the effective interest rate your funds will earn is 3.5%.
- Lock-In Period Ends: As soon as the lock-in period ends, the company will return your money after deducting the discontinuance charges, management fees, etc. Don’t expect to receive 100% of your invested amount. You might receive around 60 to 70% of your invested amount as they collected the rest as mortality charges for life cover.
- Tax Implications: The surrender amount you receive will be added to your current year’s income, and you need to pay tax according to your income tax slab. Also, any deduction you had claimed in previous years under Section 80C based on the ULIP premiums would be reversed. They would be added back to your income in the year you get the surrender value amount. TDS (Tax Deducted at Source) will also apply to the surrender value. Please check with your CA on how much taxes you might be paying.
Option 2: Surrendering the ULIP policy after the lock-in period ends
Surrendering your ULIP policy after the lock-in period ends involves fewer financial issues when compared to discontinuing it during the lock-in period.
Here’s what typically happens if you surrender your ULIP policy after the lock-in period:
- No Surrender Charges: Insurance companies will not impose surrender charges after the lock-in period expires. This means you can surrender the ULIP without incurring the penalties that would have applied during the lock-in period.
- Termination of Insurance Cover: Once you surrender the ULIP, the insurance cover provided by the policy ceases to exist. If you still require life insurance coverage, you may need to explore other insurance options.
- Full Fund Value: Upon surrendering the ULIP after the lock-in period, you should receive the full fund value of your investment. This amount is determined by the accumulated value of the investment funds chosen within the ULIP.
- Tax Implications: If you surrender your ULIP policy after the lock-in periods, the surrender value is tax-free if the annual premium you paid is below ₹2.5 lakhs per year.
Option 3: Convert your ULIP to a paid-up policy
Converting your ULIP policy to a paid-up policy is an option available if you do not wish to continue paying premiums but want to keep some value from your investment. In ULIPs, you can convert your policy to a paid-up policy only after the lock-in period (5 years) ends. To be sure, check your policy document.
Here’s what typically happens when you convert your ULIP policy to a paid-up policy:
- Premium Payment Cessation: By opting for a paid-up policy, you inform the insurance company that you no longer wish to pay future premiums. This means you stop making regular premium payments.
- Reduced Sum Assured: The sum assured (life insurance coverage) is reduced to an amount proportionate to the premiums already paid. They typically calculate the reduction based on the premiums paid and the remaining policy term.
- Conversion to a Paid-Up Fund: The fund value of your ULIP, which represents the investment component, is preserved, and they convert the policy into a paid-up fund. This fund continues to be invested, and its performance is linked to the market.
Now that you have understood the 3 options available, let’s discuss which one is right for you.
Which option is best for you? Should you discontinue your ULIP policy immediately, surrender your policy after the lock-in period ends, or convert your policy to a paid-up policy?
Let’s be clear that the 3rd option, to convert your ULIP policy to a paid-up policy, is the worst. If the lock-in period of your ULIP policy is over, immediately stop your further premium payments.
Take out the surrender value – buy a term (life) insurance if you don’t have one and invest the rest in other investment options.
Converting your ULIPs to a paid-up policy won’t help you in any way. It’s an option designed by these companies to hold your money for a longer time to keep earning management fees from you.
Things get tricky when your policy is still in the lock-in period. Here, the right option for you, whether to discontinue the ULIP policy immediately or surrender after the lock-in period ends, depends on the number of premiums paid, opportunity cost and tax implications.
Let’s look at two scenarios:
Scenario 1: Paid ULIP premium for 1 or 2 years
If you are in the early years of your policy and have paid a premium for 1-2 years, then go with the 1st option. Discontinuing your ULIP investments right away is the best option for you.
Yes, you will lose your life cover immediately. They will charge you discontinuance charges, and the money you will receive at the end of 5 years will be lower than the amount you have invested. But that’s okay. Take this hit. Think of this as a fee you paid for your mistake.
Because here, you still have a chance to minimize your losses. Use your future premium amount to buy a term plan with better coverage and invest in an equity fund which can give you better returns.
If you buy term insurance and invest the rest of the premium in an equity fund (index fund) you will end up making more wealth and have a better life cover when compared to your ULIP policy.
Looking for our calculations? We won’t provide it here. Because there are different types of ULIP policies available in the market. We need to make too many assumptions to share a basic calculation. We don’t think it is the right thing to do.
So, we will do something better. If you have invested in a ULIP or are about to invest in a ULIP, email us your ULIP policy document and other details to this mail ID – firstname.lastname@example.org . We will share the calculations based on your ULIP policy, and you can decide whether the particular ULIP policy is a good investment or not.
Scenario 2: Paid ULIP premium for 3 or more years
Generally, we would have said, if you have realised an investment mistake, rectify it immediately. But in this scenario, where you have paid 3 or more premiums on your ULIP policy, things get tricky because of income tax.
Did you claim tax deductions under Section 80C for your ULIPs investments in the past few years? If yes, discontinuing your ULIP policy will nullify all your tax deductions. Hence, all tax deductions claimed against ULIP will be accounted as income and taxed according to your tax slab.
This tax deduction issue is manageable if it’s just 1 or 2 years because the returns generated from your future investments will help you recover from this. But when it’s about 3 to 4 years – it will be hard to recover this loss, including the discontinuance charges and lower returns on the discontinuance policy fund.
Therefore, it might be wise to wait till the lock-in period ends and then surrender your ULIP policy. Here, you won’t have to pay any surrender charges. Also, your surrender value will be tax-free.
Buy a term plan for better life coverage, and invest the lump sum surrender amount you receive in an equity fund based on your financial goals, risk tolerance and time horizon.
Share it with your friends and family. Spread awareness!
In personal finance, mistakes are inevitable. The key is to learn from them.
When it comes to ULIPs, the decision to discontinue early or wait until the lock-in period ends depends on the number of premiums paid, tax implications, financial goals, and risk tolerance.
Before making any decisions, assess the specific terms and conditions of your ULIP. Understand the surrender charges, evaluate the tax implications, and consider alternative investment options that align better with your financial objectives.
Remember, your financial journey is a marathon, not a sprint. Take the time to educate yourself, seek professional advice, and make decisions that will pave the way for a secure and prosperous future.
Share these insights with your buddies. Until next time!
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