Unit Linked Insurance Plans (ULIPs) offer a combination of investment and insurance, providing a safer investment option amidst market turbulence. Despite their benefits, ULIPs are often confused with mutual funds (MFs) due to similar advertising strategies. The Insurance Regulatory and Development Authority of India (IRDAI) has intervened to reduce this confusion, ensuring clearer communication about ULIPs’ nature and risk factors.
Clarifying the ULIP-MF Confusion
Some insurers have heavily advertised their mid- and small-cap funds, while distributors and agents have leveraged the popularity of mutual funds to sell ULIPs. This has led to confusion among customers, who may not always understand whether they are purchasing an insurance product or an investment fund.
“A cursory glance at some insurers’ advertisements could lead less savvy investors into thinking they are investing in a fund. The reality is they would invest in a ULIP, which would invest in a fund. In a ULIP, one bears a mortality charge for the insurance cover,” explains Deepesh Raghaw, a SEBI-registered investment advisor (RIA). This mortality charge increases with age, leading to a bigger impact on the maturity amount for senior citizens.
Following IRDAI’s directive, insurers are expected to highlight both the insurance and investment aspects of ULIPs more clearly, helping to reduce investor confusion.
Benefits of ULIPs
Lock-In Period
ULIPs come with a five-year lock-in period, which can be beneficial for investors prone to using funds meant for long-term goals for short-term needs or withdrawing money from equity MFs during market downturns. The lock-in period helps maintain investment discipline and focus on long-term wealth creation.
Tax Benefits
If the premium is up to ₹2.5 lakh per annum, the maturity amount of a ULIP is tax-free. Additionally, rebalancing between funds within a ULIP is also tax-free, unlike equity MFs, where long-term capital gains are taxed at 10%.
Waiver of Premium Feature
ULIPs offer a waiver of premium feature, which can be particularly useful for goals like saving for a child’s education. In the event of the policyholder’s demise, the insurance ensures that the child receives the intended sum, ensuring financial security.
Challenges and Considerations
Liquidity Issues
One of the primary challenges with ULIPs is liquidity. During the first five years, funds cannot be withdrawn, posing a problem in case of emergency financial requirements. “If you have an emergency requirement, you cannot pull out money in the first five years,” says Vishal Dhawan, chief financial planner at Plan Ahead Wealth Advisors.
Higher Mortality Charges
ULIPs typically have higher mortality charges compared to term plans. This can result in lower returns for older investors due to the increased cost of insurance. Furthermore, the investment component of ULIPs may underperform, and investors cannot switch to another insurer’s fund until the lock-in period ends.
Underinsurance Risk
There is also a risk of remaining underinsured with ULIPs. Unlike pure investment products where returns are based solely on the fund’s performance, ULIPs’ returns can be lower for older policyholders due to higher mortality charges.
Key Checks Before Investing in ULIPs
Before investing in a ULIP, consider the following:
- Investment Horizon: ULIPs are ideal for long-term wealth creation over more than 10 years. “ULIPs are an excellent product for customers who believe in long-term wealth creation over more than 10 years,” says Piyush Trivedi of Kotak Mahindra Life Insurance Company.
- Liquidity Needs: Ensure you do not need access to the funds within the lock-in period.
- Premium-Payment Ability: Assess your ability to consistently pay premiums.
- Section 80C Deduction: Ensure you have space within Section 80C to avail of the tax deduction.
Types of ULIPs
There are two types of ULIPs: Type I and Type II.
- Type I ULIP: In the event of the policyholder’s demise, the nominee receives the higher of the investment value or the sum insured.
- Type II ULIP: The nominee receives the sum insured plus the investment value.
“If you are investing in a ULIP for returns, go for a Type I ULIP. If you are investing for insurance cover as well, Type II is better,” advises Raghaw.
Before committing to a ULIP, review the past performance of the insurer’s various funds. Investors seeking greater flexibility might prefer a combination of a term plan and mutual funds.
In summary, while ULIPs offer a blend of investment and insurance with potential tax benefits and a disciplined savings approach, it is essential to understand their features, charges, and limitations to make an informed investment decision.
