Personal Finance

Policyholders must understand that ULIPs are more a long-term market-linked savings product with minimum insurance cover

Unit Linked Insurance Plans or ULIPs offered by insurers are a popular avenue for investors, thanks to the tax exemption on premium payments made and maturity proceeds received, and the flexible market exposure provided in these instruments. Though the tax exemption on maturity proceeds was tweaked in 2021 to limit it to lower premium policies (less than ₹2.5-lakh premium), ULIPs remain a popular choice. However, the policyholder must understand that ULIPs are more a long-term market-linked savings product with bare minimum insurance cover. Here are three things that policyholders should know:

Insurance cover insufficient

The premiums paid by policyholders will be diverted into two main heads. One is the mortality premium which creates the risk cover; The other larger part of the premium will be invested into an investment fund chosen by the policyholder.

. This distinction is critical as each part serves a different purpose — the former, insurance and the latter, investment. The death benefit in ULIP is generally the higher of basic sum assured (which is 10 times the annual premium) or the fund value at the time of claim. This implies that only if one pays their entire annual income in ULIP premiums will they receive a life cover worth 10 times the income, making it an improbable proposition for insurance in the early stages when the fund accumulation has not grown to size. This makes getting a death benefit with ULIP in the early period of the policy term a not-so-good idea. Term insurance, for instance, provides a death cover of 20-25 times annual earnings starting from a premium of ₹15,000 for a 30-year-old.

Also, even assuming death claim is made in the later stage of the policy and the fund value is higher, policyholders ideally should not count on investment fund as an insurance cover. Just as assets are funded differently (insurance and investment), the proceeds should also serve different purposes (death benefits through insurance and asset creation through investments.)

Some policies also allow for fund accumulation to continue in case of death of policyholder as well. HDFC Life Click2Protect Premium Waiver ULIP, for instance, the premiums are waived on death of the policyholder allowing for continued accumulation of the policy fund. The waiver of premium option is a popular feature with many other providers as well. In this case, the policy works like an investment product.

Covered?

Even assuming death claim is made in the later stage of the policy and the fund value is higher, policyholders should not count on investment fund as an insurance cover

Too many Investment options

ULIPs can invest across equity and debt as well as give you hybrid options. Beyond this, strategies based on time to goal, discretionary (based on preference of the policyholder) or pre-defined rule-based strategies (based on valuations and volatility across equity and debt, for instance) are available for investors. This implies an availability of at least five to 15 funds/strategies in ULIPs each with a different allocation to different asset classes. Policyholders can switch between these funds at no cost — starting from at least four switches per year to unlimited switches. But the availability of options should not be the basis for exercising the same excessively. Long-term investing can be successful if one sticks to the basic tenets.. For example, younger age implies a higher time to goal which gives enough room to absorb losses in equities and hence, one can have a higher risk appetite and invest in equity funds. If you do not have the risk appetite or your goals are much closer, hybrid or debt-oriented funds may be better.

Tax attractiveness diluted

Premium payments for ULIP funds continue to be eligible for tax exemption up to Section 80C’s ₹1.5-lakh limit. The death benefit received by the policyholder is also tax exempt under Section 10(10)D. The main change has been that benefits received from ULIPs are taxable if the premium paid is more than ₹2.5 lakh per annum. Even if the cumulative premiums paid in a year for ULIPs exceed the limit, the returns from the ULIP are taxable . This has diluted the attractiveness, but is still a valid draw for policyholders.

One should have a proper insurance cover before considering ULIPs, which are more of a play on tax-efficient investing than insurance. Time is the other investment one must commit to for ULIPs. With a predominant equity exposure, a minimum five-year lock-in period and long-term goal-based investing (retirement or children’s education) would necessitate a minimum 10-15 year investment period for the fund to deliver good value.

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Published on May 21, 2022