05 Sep 2018 20:11 IST

Know your ULIP before investing

With the equity market going up, unit-linked insurance plans are popular again

If there is a financial product that is selling like hot cakes today, it is the unit-linked insurance plan (ULIP). A ULIP is a combo product that offers life insurance and a market-linked investment. With the equity market moving up, ULIPs are in the limelight.

With the government’s announcement during the Budget to tax long-term capital gains on equity investments at 10 per cent, ULIPs are more popular than ever as they remain exempt from tax. They are treated differently under the Income-tax Act due to the ‘insurance’ component. Maturity proceeds from ULIPs are tax-exempt under Section 10 (10D) — provided the sum insured is at least 10 times the annual premium. Today, most insurers meet this requirement.

An added advantage is that the premium invested can be claimed as a deduction from income, up to a maximum of ₹1.5 lakh under Section 80C. ULIPs have turned more consumer-friendly post the 2010 regulations, where expenses were capped and a five-year lock-in was imposed by insurance market watchdog IRDAI.

Watch out

Before signing up for a ULIP one needs to understand a few critical aspects about its structure and working. One, charges in ULIPs are front-loaded. Though, after the 2010 regulations, charges have been capped (the difference between gross yield and net yield can’t be more than 2.25 per cent on maturity), they continue to be loaded on to the premium in the initial years.

Two, there is a five-year lock-in. If you intend to discontinue the policy, you may stop paying premiums but the money already paid can’t be taken out for five years.

Three, the insurance component is small and may not suffice for an individual’s requirement. The life cover may be 10 or 20 times the premium, but the cover is much higher in a term life insurance.

Saving charges

Further, one needs to understand that the charge structure in ULIPs is different from what is seen in mutual funds. While in MFs the net asset value (NAV) captures the value of each unit of investment after all costs, in ULIPs, the NAV is the value of the fund minus one charge — which is the fund management charge. The policy administration charge, mortality charge and charges, if any, for switching funds, are adjusted by cancellation of the outstanding units. So, your actual return from a ULIP will be lower than the returns based on NAV. However, the new-age ULIPs don’t have many of these charges.

HDFC Life was among the first to launch an online ULIP in 2014. Saving on intermediary cost, the company offered it with ‘zero’ premium allocation and ‘zero’ policy administration charge. Today, there are many online ULIPs and their expense structure is as low as direct plans of MFs. They also have competitive features — refund of the mortality charge (as in the case of Bajaj Allianz Goal Assure), a fund management charge of just 1.25 per cent for equity (Max Online Savings Plan), and a return booster by providing loyalty addition (Edelweiss Tokio Life Wealth Plus).

MF advantage

While ULIPs are essentially the same as MFs, some experts think that they are not as good as the latter as they are poor on transparency and liquidity. Insurance companies disclose facts about products in brochures, but they are loaded with jargon, which makes the product suitable only for informed investors.

In terms of liquidity, ULIPs lose out again. Even if the fund underperforms, one has no option but to stay put for five years. In MFs, they can switch to other funds with ease.

Besides the lack of flexibility, one also makes a commitment to pay a lumpsum premium for five years in ULIPs. In the interim, if a person decides to stop, they can’t pull their money out. Hence, for investors with a short-term investment horizon, MFs are still a better choice.