Why You Shouldn’t Exit Your ULIP After Lock-In Period Ends
While investing in any life insurance plan, it is important to ensure that the product features align with your long-term goals. One of the options available is the Unit Linked Insurance Plan (ULIP), which provides life insurance along with an opportunity to get market linked returns. A ULIP enables investors to pursue their objective of wealth creation through investing in equity or debt-based funds (or both) in accordance with their long-term goals. ULIPs have become one of the most popular investment tool that also provides life insurance cover along with investment opportunities that help you achieve your life goals.
Characteristics of ULIPs in brief:
• Transparent & Flexible: ULIPs are popular due to their transparency and flexibility, as they allow investors to choose the fund option according to their risk appetite.
• Financial Planning: ULIPs are suitable for those who are looking for investment options to get their financial goals done.
• Long-term investment: ULIPs are long-term financial products, which also provide life insurance cover.
• Switching: ULIPs provide investors with the option to switch their portfolio between equity and debt funds.
• Tax Benefits: People invest in ULIP schemes because of its tax benefits.
Types of ULIPs
Based on the types of funds, ULIPs can be divided into different types.
A. Funds ULIPs invest in
a. Equity funds: The premium paid is invested in equity markets. These are subjected to higher risks and offer relatively higher returns
b. Debt funds: The premium paid is invested in debt instruments. These are subjected to lower risks, but also offer comparatively lower returns
B. Few objectives of ULIP investments could be:
a. Child’s education: Long-term investment made for a child’s education, or savings for unforeseen circumstances
b. Wealth creation: Investments made for wealth creation, and for achieving future financial goals
c. Retirement: Investments made to save for retirement, whilst still being employed
C. Death benefit
a. Type I ULIP: This type pays the higher of the sum assured or the fund value in case of death of policy holder to the nominee
b. Type II ULIP: This type pays the total of sum assured value and the fund value in case of death of policy holder to the nominee.
How ULIPs work
When you invest in a ULIP, your premium is invested in funds of your choice., by the insurance company. The plan provides life cover for which mortality charge will be deducted.
ULIPs also provide investors with the option to switch their portfolio between equity and debt funds depending on their risk appetite. This flexibility allows the investors to choose a plan that aligns with their goals, which has contributed to ULIP’s popularity as an investment plan.
In 2010, the Insurance Regulatory and Development Authority of India (IRDAI) brought in a few changes, and one of them pertaining to ULIPs was to increase the lock-in period from 3 years to 5 years. That is, no liquidity is offered during the 5-year lock-in period. Considering the fact that life insurance is a long-term product, investors might not enjoy the complete benefits of ULIPs unless they hold it for the entire duration of the policy.
ULIP Tax Benefits
Under Section 80C of the Income Tax Act, 1961, the premium paid towards ULIP plan is allowed as a deduction, with the maximum amount allowed being Rs. 1.5 lakhs. The amount of deduction will be restricted up to 10% of actual capital sum assured if policy is issued on or after 31 March 2012 other wise 20% of actual capital sum assured.
ULIPs also offer tax-free maturity. As per Section 10 (10D) of the Income Tax Act, 1961, the annual premium should be less than or equal to 10% of actual capital sum assured if policy is issued on or after 1 April 2012 otherwise 20% of actual capital sum assured. These tax benefits make ULIP an attractive investment option, and with features such as fund switching and partial withdrawal, ULIPs have become a popular investment option for policyholders.
Why exiting ULIPs immediately post lock-in period is not a good idea
There are investors who buy ULIPs not as long-term investments, but as medium-term investment options, and exit ULIPs once the lock-in period ends. The objective here should be achieving your Life Goals in the long run. However, if that’s not the case, then you do not get the complete benefits from ULIP returns. Moreover, ULIP charges are applicable in the initial 5-year lock-in period.
These charges remain and recovery of the same along with returns requires time. Thus, the real benefits of ULIP plans can be derived after the lock in period ends.
Different types of fees and ULIP charges
1. Premium Allocation Charge (PAC): The Premium Allocation Charge is the fixed percentage that is deducted from the premium paid. PAC is front-loaded; that is, if the PAC is 10 percent on a premium of Rs. 80,000, then Rs. 8,000 gets deducted, with the remaining amount being made available for fund allocation.
2. Mortality Charges: Mortality charge is deducted for the insurance coverage provided under the policy/plan. Mortality charges vary from one individual to the other, and depend on various factors such as age and sum assured, and are deducted every month through cancellation of units.
3. Fund Management Charge (FMC): Fund Management Charge (FMC) is charged by the insurance company for managing various funds in ULIP scheme. The net asset value (NAV) is adjusted according to the charge, and the maximum charge allowed is 1.35% p.a. of the fund value. This charge is deducted on a daily basis.
4. Policy administration charge: The policy administration charge is levied for the administration of the policy. The charge is either flat throughout the policy period, or could vary at a predetermined rate, and is deducted every month by cancellation of units from the fund value.
5. Partial withdrawal charge: Investors can opt to partially withdraw the funds, and while some plans offer unlimited withdrawals, others only offer limited withdrawals. These can either be free up to a certain limit, or are charged based on the transactions depending up on the product terms and conditions.
6. Fund switching charge: Fund switching charges are applicable when the funds or investments are moved between the various fund options. This is free up to a certain limit, or could incur a charge per switch depending up on the product terms and conditions.
7. Surrender charge: ULIPs have a lock in period of 5 years. Surrender charge is applicable only if you surrender your policy before the lock in period i.e. 5 years.
Exiting during a dip in the market can prove to be costly
ULIPs are market linked products and allow you to invest in equities—helping in wealth creation over the long term, and thereby enabling investors to achieve their long term life goals. Equities do come with intermittent volatility and correction, but has been among the top performing asset classes over the longer term, as indicated by historical data. Therefore, investors should not get overtly influenced by short term market volatility/corrections and discontinue their ULIP investments. Investors who are risk-averse can also consider partially switching to relatively less risky (or less volatile) fund options like bond / liquid fund, in the event of market volatility/correction. ULIPs are tax efficient and allow an investor to switch to various fund options (multiple times) without any charges and capital gains tax implication, thereby allowing them to manage their asset allocation efficiently.
Overall, ULIP plans are a long term investment product, and investors should not get deterred by short term market volatility/correction, and continue to invest using a systematic approach, thereby enabling them to create wealth (through the power of compounding) and achieve their long term investment goals.
ULIPs are long-term financial products, and offer policyholders the dual benefit of life insurance with investment. It is important to remember that to reap the benefits of the ULIP scheme, the investors have to hold on until the policy matures. If the ULIP is purely equity-oriented, during the market fluctuations, it is important to hold on until the market bounces back, instead of exiting, hence it is better to plan your investments in ULIP products with a longer time horizon in mind to get your Life Goals Done.
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