Human Life is full of uncertainties; we risk getting sick or having an accident, which might put us in financial hardship. People can safeguard their loved ones and themselves from these concerns by purchasing life insurance. Life insurance essentially values A person's life financially, which accounts for the possibility of future income loss. If a covered event, such as death or incapacity, occurs, the guaranteed sum paid out is known as the Sum Assured in life insurance.
Let's talk about the Unit Linked Investment Plan or ULIP in detail. It's a life insurance that mixes investment and risk coverage. The fluctuations in the stock market directly impact how well ULIPs perform. The investor assumes the investment risk in ULIPs, and the invested amount is expressed as units, which is monitored by the Net Asset Value (NAV). Once fees and the cost of risk cover are subtracted from the premium paid into a ULIP, the premium goes towards funding the fund. The total number of units multiplied by their present value at any one time determines the fund's value.
Key Features of ULIPs
Life Insurance
The primary distinction between life insurance coverage and mutual funds is this. Although ULIP funds do not cover life insurance, the mutual fund does. While mutual funds do not cover life insurance, ULIP provides investors with certainty by covering all aspects of investing in stocks and bonds.
Insurance Cover and Premium Factors
ULIPs offer coverage that is generally 10 times the premium paid. It is because there is a rule, Income Tax Section 10 (10D) Exemption is available if the amount of premium on the life insurance policy does not exceed 10% of the actual capital sum assured. Many factors influence premiums, including age, medical history, sum assured, smoking status, gender, and place of employment. A key component of ULIPs, mortality charges, drop yearly due to the combined effects of age and rising fund value.
Charge Structure
A number of charges associated with ULIPs are frequently the subject of criticism. These charges include those related to death, fund management, premium allocation, policy administration, fund moving, partial withdrawal, discontinuation, and surrender. But ULIPs have changed over time. Some firms have eliminated most fees, keeping only fund management and mortality costs.
Lock-in Period
While mutual funds do not have lock-in periods, the ULIP programmes do. Certain schemes have a three- to five-year term during which investors cannot break their bonds or even withdraw the money they have raised—only the amount they have deposited. However, investors in mutual funds have infinite time to redeem their investments. Only mutual funds are subject to this lock-up period under the ELSS (Equity Linked Savings Scheme), with a minimum duration of three to four years.
Liquidity
There is no liquidity in ULIP since it has a lock-in term. While the invested cash in mutual funds has no lock-in other than ELSS, investors cannot utilize their money for any other purpose. The terms and conditions of the mutual fund, which are known to be official when individuals invest in these schemes, contribute to its good liquidity, highlighting the key distinction between ULIPs and mutual funds.
Taxation
The government offers a tax deduction of around 1.5 lakh per year for ULIPs under section 80C. However, another distinction between mutual funds and ULIP is that there is no deduction in mutual funds.
Expenses
There are large fees and certain expensive premiums associated with investing in ULIPs; nevertheless, mutual funds have no high fees or excessive charges, making them more flexible with money. Charges for fund management, allocation, mortality, and other administrative expenses are all associated with ULIP. There are no departure or admission fees for mutual funds.
Transparency
A person is encouraged to invest more when they see transparency, however mutual funds exhibit transparency in greater detail than ULIPs, which illustrates some complexity in the concept.
Fund Switching
The ability to swap between funds is provided by ULIPs, based on the investor's demands and the state of the market. This lets you match all of your assets to your desired level of risk and your financial objectives. You can quickly move to equity funds if you're ready to take on greater risk. Additionally, you can convert to debt funds if you're not willing to take on any risks.
Risks Associated with ULIPs
- The risk associated with ULIP plans will depend on the type of fund attached to it. For example, an equity fund is riskier than a debt fund, while a balanced fund shares the risk between the mix of equity and debt portfolios.
- The ULIP plan will carry the risk factor accordingly. ULIPS are also riskier when compared to other investments. In contrast to a mutual fund product or a stand-alone insurance plan, ULIPS entails higher risk.
- The cost structure of ULIPS makes it pricey, and it becomes challenging to obtain returns that would assist you in adding to your initial investment and cover your costs.
Let’s Compare
ULIPs vs. Mutual Funds
Selecting between mutual funds and ULIPs requires weighing their unique characteristics. ULIPs may have higher costs and a lock-in period but offer insurance and investments with market-linked returns. Conversely, mutual funds appeal to a range of investing tastes because they offer flexibility, various selections, and no set lock-in time. Depending on your risk tolerance, financial objectives, and liquidity requirements, you can choose the best option.
ULIPs vs. Other Life Insurance Policies
Conventional life insurance products only provide fixed-return life insurance. Although ULIPs may have higher costs, they offer flexibility and the possibility of bigger returns. Make a decision depending on your risk tolerance, financial objectives, and preferred investment-related rewards.
ULIPs vs. Fixed Deposits
Fixed Deposits offer a safe, fixed-rate investment option. Fixed Deposits are recommended for assured returns with low risk, whereas ULIPs are appropriate for individuals looking for a combination of investment and insurance. Pick according to your financial objectives and risk tolerance.
To Sum Up
Hope this helps you in deciding whether a ULIP is good for investment or not. However, in the present scenario depending on different case studies, people usually avoid investing in ULIPs. There can be multiple reasons, as discussed above, for the same. One major is that there is not an appreciable amount of compounding that can be seen in returns through ULIPs compared to other investment options.