- Date : 02/01/2020
- Read: 6 mins
With many different types of ULIPs available in the market, it is important to make sure that you invest in one that meets your investment goals and your insurance needs.
In Part 1 of this series, we learnt what a ULIP is, and why you should invest in one. In Part 2 of the series, we will learn about the different types of ULIPs available, and how to choose one that best meets your requirements. We will also take a look at the eligibility criteria and the charges involved in ULIPs.
Types of funds offered in ULIP:
Most insurers provide different types of funds that you can invest in through ULIPs. These are:
1. Bond Funds
Also known as Income Funds, these are invested in fixed income instruments, corporate bonds, and government securities. Investments in bond funds carry low to medium risk.
2. Equity Funds
These funds primarily invest in large and mid-cap equities and are considered to be high risk. These are suited for investors who have an otherwise debt-heavy portfolio or have a high-risk appetite.
3. Cash Funds
Also known as Liquid Funds or Money Market Funds, these investments are made in short-term instruments, which include cash deposits, treasury bills, and commercial papers. These funds generate the lowest returns but are considered to be highly secure.
4. Balanced Funds
Also known as Asset Allocation Funds, Balanced Funds have historically been the most stable of all the ULIP options available. They invest in a market-driven mix of equity and fixed interest instruments and carry a medium to high risk. This is dependent on the distribution of assets between the various instruments.
Types of ULIPs:
Other than the underlying fund type, ULIPs can be further classified based on the end-use of the funds and the type of death benefits offered. Let us look at each of these categorisations in detail.
The end-use of funds:
- Retirement planning: Build a retirement corpus while you are still employed.
- Child education: Invest, keeping the long-term goal in mind, to fund your child’s higher education.
- Wealth creation: Build a large corpus that can be used for any future expense.
Death benefits offered:
- Type I ULIP: This type of ULIP pays the higher of the assured sum value or the fund value to the nominee in case of a claim.
- Type II ULIP: This type of ULIP pays the assured sum value, including the fund value to the nominee in case of a claim.
How to choose the right ULIP?
With many different Unit-Linked Insurance Plans available in the market, selecting one to invest in may seem like a daunting task. Here are a few things that can help you make the right decision.
1. Get sufficient cover
Remember that the primary aim of an insurance plan is to provide financial protection for you and your dependents. Therefore, make sure that the assured sum value of the ULIP is high enough to cover your insurance needs from day one. Do not depend on the investment part to provide coverage as all investments carry some risk.
2. Choose investments based on your financial goals or risk tolerance
Before you decide where to invest your money, you must determine your reasons for choosing a particular investment. Equity funds have high long term growth potential, whereas debt funds keep your capital safe and preserve your wealth. A mix of the two can provide you with the best of both worlds. Also remember, since ULIP is part of your overall investment portfolio, it should be based on your overall risk profile as well.
3. Choose long term investments
ULIP is best suited if you are willing to stay invested over the long term. Look for plans that offer bonuses like loyalty additions and wealth boosters. This will help you build a larger corpus.
4. Account for tax benefits
When comparing ULIPs with other investment avenues, make sure you account for any tax benefits you get on ULIPs under Sections 80C and 10 (10D) of the Income Tax Act, 1961. It is also important to remember that the amount received on maturity is tax-exempt under Section 10(10D). Further, unlike stocks and mutual fund investments, ULIPs don’t attract any capital gain taxes.
5. Understand the key features offered
Primary features that can be compared are:
- Fund switch: An option to switch funds.
- Premium redirection: An option to invest future premiums in a different fund.
- Partial withdrawals: An option to withdraw part of your accumulated money.
- Top-ups: An option to invest your surplus money into the existing policy.
ULIP charges and premium calculation:
Various charges may be involved in carrying out ULIP related operations. These include:
- Premium allocation charge: These charges are typically a fixed percentage of the premium in the early years of the policy. They are used for initial and renewal expenses, and for any commissions involved. These charges are front-loaded and are waived after the first few years.
- Mortality charges: This is the cost of the insurance cover provided. It depends on factors like age, sum assured, the health profile of the insured, etc. This is typically charged monthly.
- Fund management charges: This is the fee for the management of the fund. It is charged daily and cannot be higher than 1.35% per annum of the fund value. Typically, it is higher for equity funds compared to debt funds.
- Partial withdrawal charge: This is a fee charged when making a partial withdrawal from your ULIP. Most insurers allow for two to four free withdrawals and charge per transaction after that.
- Switching charge: Most insurers allow a fixed number of free switches. Switches beyond this fixed number attract a charge per switch. This is typically between ₹100 and ₹250.
- Policy administration charges: This charge is levied every month and can only be deducted by cancelling underlying units. It could either be a fixed charge or a percentage of the premium, depending upon the insurer.
ULIP is a great way of combining insurance and investment in a single instrument. It provides you with financial protection while also promising a return on your investment. Keep in mind that the returns are subject to market risk, but the trade-off can be worthwhile if you have the right risk profile.
Further, ULIPs are a great tool for long-term systematic savings as the five year lock-in period ensures that one cannot withdraw any amount for impulse purchases. It forces a discipline on individuals who tend to splurge and dip into their savings frequently.
Take a look at how and why you should monitor your ULIPs after purchase to understand how the ULIP journey does not end once the investment has been made.