Why Should You Invest in ULIPs?

The 2018 budget introduced a long-term capital gain (LTCG) tax under which investors need to pay 10% tax on long-term capital gains on profits earned in excess of Rs 1 lakh from the sale of shares or mutual funds retained for more than one year from the date of purchase. However, under prevailing laws, ULIPs do not attract long-term capital gain tax. ULIPs are an alternate arrangement to get returns from investing in equity via equity-based funds which are exempted from LTCG tax. Long-term capital gains above Rs 1 lakh on mutual funds are taxable. Under the circumstances, investors looking for equity-based returns can invest in ULIPs with higher exposure to equities, in order to reap tax-free returns.

Building wealth is not an easy task. You cannot do it in fits and starts. You need to invest steadily in plans which offer returns which exceed projected inflation. You can only achieve future financial freedom when wealth management is done in tandem with income. ULIPs can be an investment vehicle which are market-linked product that combine the best of insurance and investment. ULIPs are associated with the capital market and offer flexibility to choose funds out of equity, debt or balanced as per your risk-taking ability. So, if you want to build wealth and would not shrink from taking risks on your investments, you can go for equity funds. Likewise, if you want to reap steady returns on your investment, you can invest in debt funds. You can easily evaluate past performance of the fund you are interested in before you decide to invest in it. Besides, you could use the top-up option to invest more if you have surplus funds. Top-ups reduce the overall cost of ULIPs for the policy holder and also increases the life cover. Top-ups are typically charged at 1 to 2 percent, which is less than the base-plan charges. Top-ups are useful when you are looking at buying more units at a lower cost, as it reduces the total average cost.

As returns are compounded, ULIPs are a good option for long-term investment. With a lock-in period ranging from three years to five years, ULIPs allow invested funds to remain untouched for a minimum tenure of 5 years. If you wish to reap the best benefits, you need to remain invested in for a period of 10 years.

Your financial needs keep changing at different stages of your life. ULIP features like partial withdrawals, multiple fund options, numerous premium payment options can be used to personalize your savings schedule. ULIPs offer the flexibility of switching and redirection. Switching is a feature which allows you to change your current proportion of investment from one fund to another owing to market fluctuations, your changed risk-taking ability, etc. Redirection, on the other hand, lets you chalk out the investment amount into different portfolios for future investments, while keeping your present investment set-up as it is. These features make ULIP different from other investment products as they are not available in mutual funds or other financial products. These features are usually free of charge for most ULIPs or incur nominal charges, when applicable. ULIP also offers liquidity in the form of “partial withdrawals”, which allow you to withdraw a portion of your fund after a specified time period. There are minimum and maximum limits outlined for such withdrawal, which are likely to differ from one plan to another.

The yearly premium (including applicable taxes, cess, and other charges) of a ULIP is eligible for tax deduction under section 80C of the Income Tax Act, 1961. The maximum permissible limit to avail the tax deduction under section 80C is Rs 1.5 lakh. For ULIPs bought after 1st April 2012, the maximum tax deduction can be availed if the premium amount is less than 10% of the sum assured. If the premium of your ULIP is more than 10% of the sum assured, you can avail a maximum tax deduction of up to 10% of the sum assured. For ULIPs bought before 1st April 2012, the maximum tax deduction can be availed if your premium amount is less than 20% of your sum assured. If the premium of your ULIP is more than 20% of your sum assured, the maximum tax deduction you can avail is 20% of the sum assured. Moreover, ULIP offers tax-free maturity value under Section 10 (10D) of the Income Tax Act, 1961 if the annual premium is less than 10% of the sum assured for the ULIPs issued after 1st April, 2012.

For ULIPs bought before 1st April 2012, the maturity amount is tax-free if the annual premium payable is less than 20% of the sum assured. However, if the annual premium paid exceeds the prescribed limit (which is 10% for ULIPs issued after April 1 , 2012 or 20% for policies issued before 1st April, 2012) of the sum assured, then the entire earnings of the policy will be treated as income from other sources, and will thus be taxable as per the tax slabs applicable to you.

The amount of premium incurred by you for your ULIP policy attracts various charges. Some of them are as follows:

Premium Allocation Charges: These charges are deducted upfront before your money is invested. This is a percentage of the premium paid by you. These charges are levied to recover the initial cost incurred for procuring and issuing your ULIP, such as the commission paid to the insurance adviser, the cost of underwriting, and marketing expenses for selling the product. The money remaining after these charges are deducted is available for purchase of units of the funds you choose. Though the Insurance and Regulatory and Development Authority (IRDA) has specific guidelines to ensure a cap on these charges from 5th year onwards, the premium allocation charges in the initial years may be on the higher side. You need to keep this in mind while making your decision to go in for purchasing ULIPs.

Administration Charges: These charges are levied for repetitive administrative and maintenance charges of your ULIP. It covers the costs of paperwork, premium intimation, etc., and is normally levied on a monthly basis. It may be a flat amount or may be expressed as a percentage.

Mortality Charges: This is the expense incurred for buying the ULIP for you which is based on your age, sum assured, amount of your policy, your gender and your health conditions.

Fund Management Charge: This charge is like the fund management costs charged by different mutual fund schemes, and is levied as a percentage of the value of assets. It is deducted from the fund itself, and before computing the net asset value. IRDA has directed that life insurance companies cannot charge more than 1.35% per annum as fund management charges on ULIP products. Equity-oriented ULIPs will have higher fund management charges compared to debt-oriented ULIPs.

Fund Switching Charge: In any ULIP product you are allowed to switch from one fund to another fund free of cost for a limited number of times. So, if you wish to switch a greater number of times than the free switches you are entitled to, you may incur extra charges.

Policy Surrender Charge: If you want to surrender your policy, you may have to pay surrender charges as applicable. The surrender charges are taken for premature encasement of units, in part or in full. Surrender charges are levied as a percentage of the fund value. This is like the exit load charged by mutual funds companies when you redeem your investments before the specified period. Here too IRDA has put a cap on the maximum surrender charges that can be levied.

Q1. What is ULIP?

Ans. ULIP (Unit Linked Insurance Plan) which blends two financial products in one scheme, including investment and insurance.

Q2. What is the difference between ULIP and SIP?

Ans. While ULIP is a kind of plan which diverts your funds towards investments as well as insurance policy. On the other hand, SIP is an investment plan under which the funds are invested into securities.