Unit Linked Insurance Plan (ULIP) is a mix of insurance along with investment. From a ULIP, the goal is to provide wealth creation along with life cover where the insurance company puts a portion of your investment towards life insurance and rest into a fund that is based on equity or debt or both and matches with your long-term goals.
How does ULIP operate?
When an investment is made in ULIP, the insurance company invests part of the premium in shares/bonds etc., and the balance amount is utilized in providing an insurance cover. There are fund managers in the insurance companies who manage the investments made. Also, ULIPS allow you to switch your portfolio between debt and equity based on your risk appetite as well as your knowledge of the market’s performance. Benefits like these which offer investors the flexibility of switching is a huge factor contributing to the popularity of these investment instruments.
Is there any Lock-in-period?
Yes, there is a lock-in-period of 5 years. However, insurance being a long-term product, as an investor you may not really reap the benefits of the policy unless you hold it for the entire term of the policy which can range from 10 to 15 years.
Types of ULIPs
ULIPs are categorized based on the following broad parameters:
- Equity- Here, the investors’ money is used to purchase equity shares of one or more companies. Equity investments are considerably riskier since they’re directly linked to the fluctuations in the financial markets. However, the potential for growth is also greater. This makes ULIPs investing in equity ideal for risk-friendly investors with a high risk appetite.
- Debt- Under these types of Unit Linked Insurance Plans, the funds are invested in debt instruments such as debentures, corporate bonds, Government bonds and securities, and fixed income bonds. While these instruments carry medium to low risk, the returns associated with them are also only moderate.
- Liquid funds- Perfect for meeting short-term financial goals, these types of ULIP plans park investors’ funds in highly liquid money market instruments such as treasury bills, call money, and certificates of deposit (CD). Unlike other ULIPs, the maturity period for these funds are relatively shorter and typically range from a few weeks to months. Most of these types of ULIP investments come with strong credit ratings, making them a safe investment option for people with low tolerance to risk.
- Balanced funds- In a bid to lower the risk factor, some ULIPs invest in a mix of both equity and debt instruments. By allocating one part of the funds to equity and the other to fixed-income debt instruments, the risk is effectively spread out across high-risk and low-risk investment options. As a result, the returns offered by balanced funds are more stable and a lot less volatile than the returns obtained from pure equity funds.
- Cash funds- Certain types of Unit Linked Insurance Plans direct their funds towards very low-risk cash fund instruments such as term deposits, cash deposits, and market funds. While the returns that these types of ULIPs offer are the lowest among all the other available options, the risk factor is also negligible. This makes them an excellent choice for investors who are highly risk-averse and wish to eliminate it as much as possible.
- ULIPs based on wealth creation- Unit Linked Insurance plans are also classified according to their capacity to create wealth. These plans are formulated solely for the purpose of maximizing the return on investment. Listed and explained below are some of the different types of ULIP plans that focus on wealth creation.
- Single premium and regular premium ULIPs- As the name suggests, a single premium ULIP plan only requires a one-time premium payment due at the time of purchase. On the other hand, a regular premium ULIP allows you to pay premiums periodically throughout the tenure of the plan, right from purchase until maturity. Based on your financial situation, you can choose to pay the premiums in monthly, quarterly, semi-annual, or annual installments.
- Life-staged ULIPs- These types of Unit Linked Insurance Plans operate on the assumption that the risk-taking ability of investors goes down as they grow older. Therefore, these plans invest a part of the premium in equity instruments and the remaining premium in debt instruments. Initially, a higher proportion of investment goes towards equity rather than debt.
As the investor ages, these types of ULIPs progressively increase the proportion of investment in debt instruments and decrease the proportion of investment in equity. This effectively shifts the focus towards stable returns on investment and preservation of wealth, by lowering the risk and volatility of returns.
- Guaranteed and non-guaranteed ULIPs- The primary focus of guaranteed ULIPs is capital preservation. These types of ULIP plans limit your exposure to market risk by investing only a small portion of your premium in equity. Guaranteed ULIPs are ideal options for people looking for stable returns over a longer period of time. Conversely, non-guaranteed ULIPs focus on maximizing wealth creation by allowing you to invest a greater proportion of your premium in equity markets. The returns that non-guaranteed ULIPs offer are higher, but more volatile.
Why should you invest in ULIPs?
- Life cover: First and foremost, with ULIPs you get a life cover coupled with investment. It offers security that a taxpayer’s family can fall back on in case of emergencies like the untimely death of the taxpayer, etc.
- Income tax benefits: Not many are aware that the premium paid towards a ULIP is eligible for a tax deduction under Section 80C. Additionally, the returns out of the policy on maturity are exempt from income tax under Section 10(10D) of the Income-tax Act. This is a dual benefit that you can claim with this policy.However, in the Budget 2021 the government had announced that proceeds from ULIP shall be taxable if the annual premium exceeds Rs 2.5 lakh in any year of the term of the policy.
- Finance Long Term Goals: If you have long-term goals like buying a house, a new car, marriage, etc., then ULIP is a good investment option because the money gets compounded. As a result, the net returns are generally more. This stands true even if you want to exit after the 5 year lock-in period in comparison to not having invested the amount at all and retaining it in a savings account or in the form of an FD. But, under ULIP, the mantra is to always keep the policy going for a longer time horizon to reap the best out of it.
- The flexibility of a portfolio switch: As already mentioned, ULIPS are usually designed in a way that they allow you to switch your portfolio between debt and equity based on your risk appetite as well as your knowledge of how the market is performing. Insurance companies, on the other hand, allow a very few numbers of switches fre
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