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Why ULIPs Are A Trap: An Insipid Option For Attractive Returns

by tavaga

ULIPs are expensive, ULIPs have a lock-in, ULIPs Are No Longer Tax-Efficient

By: Tavaga Research

ULIP Meaning / ULIP Policy meaning

Unit Linked Insurance Plan is also known popularly as ULIP, is a mixed bonnet of investment & insurance vehicles, designed for the purpose of long-term wealth creation.

What ULIP means? / What is ULIP and how it works?

An investment in ULIP entitles one to life cover like any other insurance product; but also opens the doors to wealth creation, wherein, an insurance company invests part of the premium paid in equity and debt investment products. The remainder of the premium is utilized for providing insurance cover.

How do ULIPs work?

The workings of a ULIP plan can be simplified as:

  • Investors pay a fixed amount as an insurance premium for the insurance cover that they have selected.
  • The remainder of the amount is then invested by the insurance company in equity or debt instruments or balanced funds, as per the option that has been selected by the purchaser of the ULIP based on his risk appetite.
  • ‘What is the minimum lock-in period for ULIP?’ – The lock-in period for a ULIP is 5 years as per IRDAI regulations.
  • The investors can switch between investment approaches i.e., equity vs debt depending on the changes in market conditions.

Is income from ULIP taxable?

  • There are tax benefits associated with a ULIP as well. Investors can claim deduction under section 80C. The condition attached to avail this benefit is that the premium should not be more than 10% of the sum assured.
  • Furthermore, as per the latest announcements during the budget presentation, maturity proceeds for ULIPs with an annual aggregate premium payment of more than Rs. 2.5 lakh will attract long-term capital gains (LTCG) tax at the rate of 10% / 15% depending on the holding period for equity-linked investments. However, in the case of proceeds for the death of the policyholder, there would be no taxes levied on such proceeds.
  • The removal of the tax exemption that ULIP holder received, strips them of their advantage over equity fund investments.

Charges levied by ULIPs:

The combination of a term insurance plan and an assurance of long-term investment returns bundled into a single scheme might seem lucrative on paper, but one must take this with a grain of salt.

  • Fund management charges under ULIPs are capped at 1.35%.
  • In addition to this, insurers also apply other charges for the allocation of funds, mortality, and policy administration.
Premium Break up
Source: Tavaga Research

What is the sum assured?

  • It refers to the amount the policyholders would receive in case of death during the tenure of the policy.
  • The charges for mortality related expenses would differ according to the sum assured, the higher the sum assured, the higher would be the mortality charges.

Is ULIP a good investment option?

Given the high fund management charges, lock-ins, tax liabilities, and sub-par returns, ULIPs neither make a good insurance tool nor a winning investment option for the long-term.

  • The insurance cover under a typical ULIP plan is generally low. One is well off spending around 50% of the premium on a plain vanilla insurance plan to be guaranteed insurance coverage which is around 5 times as compared to ULIP.
  • With the tax arbitrage that has been taken away, ULIP investments are comparable to mutual funds.
  • The lock-in period of 5 years takes away the flexibility of investors to meet their short-term goals.
  • Partial withdrawals are allowed up to 10% of the total premium amount paid, but only after the completion of the lock-in period.

What is the right time to invest in a ULIP?

Just like any other investment option, the right time to invest in a ULIP (if the investor prefers to) would be as soon as possible. The reason why people would opt for a ULIP is 1) To be insured and 2) To generate returns on their investment amounts. The sooner you opt to go for it, the earlier you are insured and greater are the chances of earning higher returns.

“How do I maximize my ULIP return?” is one question that would surely come to the minds of policyholders. Well, the first point to take into consideration is time. The earlier you opt for a ULIP or any other investment option like a Mutual Fund or an ETF, the better. There is no “right” time to start investing.

Types of ULIPs:

ULIPs have various investment plans such as equity funds, bond funds, balanced funds, and cash funds. The risk associated with each of these funds starts with high risk for equity funds and goes down to low risk associated with cash funds.

Some of the best ULIP plans available to investors:

Aviva Life Bond Advantage Plan:

The plan has an entry age of 2 and goes up to 65 years of age. The minimum annual premium that needs to be paid for the policy is Rs. 50,000 per annum. Policyholders would have 9 investment fund options available to choose from and they can make 12 free switches in a year of a minimum amount of Rs. 5,000.

Aegon Life iMaximise Secure Plan:

The Aegon Life iMaximise Secure Plan has an entry age of 7 and it goes up to 55 years of age. The minimum premium amount for this plan is between Rs. 24,000 to Rs. 36,000 and it allows 4 free switches between plans per year. Insurance Policyholders can choose from 6 unit-linked funds, to match their investment goals.

Bajaj Allianz Future Gain:

The Bajaj Allianz Future Gain plan has an entry age of between 1 to 60 years. The minimum premium that policyholders would have to put in is Rs. 25,000 with a premium allocation charge of 0% to 1.5%. There is a choice of different funds that can be selected based on the risk appetite and investment goals of the policyholders.

ULIP vs Term Insurance Plan:

As against a ULIP, a term insurance plan would purely be an insurance plan. It does not involve any investments in securities whether debt, equity or balanced. It does not levy charges such as fund allocation and switching fees, fund management fees, policy administration fees, etc. These term insurance policies also do not require a lock-in period to be maintained.

ULIP vs Mutual Funds:

  • ULIPs offer equity, debt, and balanced funds that insurance policyholders can select from, however, have limited options for funds to invest in. If some fund does not perform well and there is a need to change, one can only switch from one category to another. This poses a major problem as far as ULIPs are concerned.
  • However, when one decides to invest in Mutual Fund schemes, whether debt, equity, or balanced/hybrid funds, one has the liberty to shuffle between mutual fund houses and sub-categories across schemes and holds a major advantage in terms of diversification across the entire universe of stocks. The non – performing fund schemes can be exited from and one can shuffle between portfolios to bring in better performers.
  • When it comes to the expense ratios of Mutual Funds, they differ according to the type of the scheme, whether aggressive or conservative. The management fees for ULIPs would thus be higher, adding to the expenses ratios that mutual funds already charge from investors.

ULIP vs ETFs:

  • In addition to mutual funds, ETFs are another low-cost, passive investing instrument that can be beneficial to investors and provide them with higher returns in the long run. As they are passive investment options, their expense ratios are lower than various mutual fund schemes and can be traded on the exchange in real-time.
  • The returns on ULIPs are on the lower side. They offer a fixed sum irrespective of whether their investments generate returns or not. On the other hand, the returns offered by Mutual Funds and ETFs are usually higher with greater flexibility available to its investors.

ULIP vs ELSS:

  • Investors earlier used to make it a point to compare between these two investment options for the tax benefits they offered and similarity in the form of the lock-in periods of 3 and 5 years for ELSS schemes and ULIPs, respectively.
  • Both have tax benefits in the form of deductions under section 80C of the IT Act. ULIPs, in addition to having a 5-year lock-in period have a limit of 10% of the sum assured on the amount that can be claimed as an exemption. Furthermore, maturity proceeds would also be subject to STCG / LTCG based on the holding period.
  • On the contrary, after taking into consideration the LTCG tax, the effective returns on ELSS schemes are higher than products like PPF or NSC schemes. ELSS Schemes have their returns linked to market movements, that are higher than returns on ULIPs.

Pros and cons of investing in ULIPs:

  • For people who would like to have their insurance and investment goals aligned with and combined into one product, ULIPs are an option that they can consider.
  • However, an insurance plan with an embedded savings or investments element in them does not guarantee a large enough insurance cover, that would suffice one’s needs, simply because of the large premium to be paid upfront. Most individuals either lack the necessary amount of funds to pay the premium or are left with a meagre amount to allocate for the investment purpose.
  • So, one is better off paying a small upfront premium to procure a relatively larger life insurance cover and then opt for investing in mutual funds to take care of investment needs. One advantage of this policy is that, even if one outlives the policy, the comparatively smaller premium lost in the case of a term insurance plan is a sunk cost one can bear. Also, one can keep a track of their investment schemes and take necessary actions if these investments do not perform well. ULIPs do not provide this freedom of exiting an underperforming scheme, and one can only switch to another scheme.
  • On a long-term basis, considering the huge costs associated with ULIPs, the majority of the ETFs and mutual funds have performed better than their ULIP counterparts

Thus, before deciding to go in for a ULIP or a normal term insurance policy, one must weigh in the pros and cons of the same, by taking into consideration the flexibility that comes with term insurance policies and choosing additional investment funds from a wider range of options. Similarly, with a change in tax implications, investing in ULIPs does not give investors an advantage over other investment instruments.

Investors must also look at their risk appetite as well as the ability to keep their funds parked in ULIPs for a period of 5 years. They should think about their goals and the kind of returns they wish to generate before making the right decision for their long-term objectives.

Disclaimer: We don’t intend to recommend ULIPs to our investors. The above ULIP Plans are only for informational purposes.

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