By Sunil Dhawan
Unit linked insurance plan (Ulip) is a hybrid product, a combo of protection and saving. It not only provides life insurance but also helps channel one's savings into various market-linked assets for meeting long-term goals. These goals could be funding children's education or marriage, making the down payment for a home or saving for one's own retirement. While saving for these goals, one also needs to ensure financial protection and Ulips facilitate both.
Ulips may not suit every investor and may not help in meeting all financial goals. Two important aspects have to be evaluated before investing in them. Let's look at them and also at their downsides.
(a) Combo-approach - All those investors, who can efficiently identify the right mutual fund schemes (across asset classes) based on their goals and simultaneously get a suitable life cover through a pure term insurance plan, may not need Ulips.
Pitfalls: Creating one's own combo gives one more flexibility and control over costs, but has its own fallouts which need to be handled well before using the combo approach.
Choosing the right mutual fund scheme may not be easy for every investor. Most investors chase recent performers and overlook several other aspects such as risk-adjusted return of a mutual fund scheme. Also, the commitment to pay regularly is not there in mutual funds which may lead to exiting or diverting funds for immediate needs, jeopardising long-term goals.
Related: How to read benefit illustration of Ulip
On the protection front, a term insurance may serve the purpose well. However, death benefit received by one's family may not be optimally put to use especially when the goal is still at a distance. Ulips are more feature-rich, wherein a 'waiver of premium' feature ensures that the family receives funds as desired initially by the insured.
It is to be remembered that you as an investor may lack the financial discipline, including the wherewithal to identify and create an optimal investment portfolio, and therefore may be unable to efficiently manage protection and savings separately.
In case you cannot manage the downsides of the combo approach, you should consider investing in Ulips.
(b) Years to goal - Investors looking at investing in Ulips should make sure that the goal for which the Ulip is to be used is at least ten years away. There is an element of insurance embedded in Ulips, which results in mortality charges. Further, there are other charges, including premium allocation charge, administration charge and fund management charge levied either on the premium or fund value. These charges are amortized over the initial few years of the policy. Therefore, an early exit is not in favour of the investor. As the impact of cost is less over the long term, that much less charge eats into your returns.
Pitfalls: Unlike the flexibility of shifting funds from one mutual fund scheme to another at the time of underperformance, switching from one Ulip to another is not possible. One may however switch among various fund options, but that does not serve the purpose. Sticking on to an underperformer for several years could be an opportunity lost.
The long-term flavour of Ulips
Unlike earlier, Ulips have become more of a long-term investment now. The new guidelines introduced in 2010 have brought about this change by increasing the lock-in period from 3 years to 5 years and also making it mandatory to regularly pay premium till the end of the chosen term.
Earlier, one would have paid for the minimum mandated 3 years and continued till the original chosen term.
Related: How Ulip can help in meeting long-term goals
However, now it's compulsory to pay each year, if one has to continue till maturity. Making this a mandatory feature has given Ulips a long-term flavour by not just increasing the minimum premium paying term from 3 to 5 years but also making it compulsory to pay till maturity.
Further, the charges in case of Ulips with a tenure of 10 years or below were capped at 3 per cent of the net yield. Net yield is the return that customer gets minus the charges. In case of Ulips of above 10 years term, total charges are capped at 2.25 per cent, of which the fund management charges are capped at 1.35 per cent. Importantly, mortality charges are outside the caps.
Investing through Ulip instils a savings habit and deters the investor from exiting or surrendering before maturity unless the goal is achieved. Capping of charges has made Ulips competitive in the long run amongst its peer products.
However, you also need to keep some other factors in mind. Varun Dua, CEO, Coverfox.com, says, "Make sure you ask the agent/broker to compare the charges and returns with mutual funds too. Save online Ulips, most mutual funds will turn out to be more cost-efficient than Ulips, especially in the less-than-10-year investment horizon."
Source: Economic Times
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