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ULIP, or a unit-linked investment plan, is a financial product that combines two very important financial products - insurance and investment. It is a type of life insurance plan that offers its subscribers death benefit to the policy’s beneficiaries while also providing an opportunity to invest. Policyholders can invest in a wide range of investment funds, this helps them tailor their ULIP to suit their investment needs and objectives. 

How Does a ULIP Work?

When you invest in a ULIP, a portion of your investment goes towards the life insurance plan’s premium and the rest is invested in the fund (s) of your choice. This way, you get a dual benefit of both investment and insurance. Understanding how a ULIP works is crucial if you’re looking to invest in one. 

This not only helps you understand if it's the right choice for you but also helps you make wise financial decisions. Here’s an explainer on how a ULIP works: 

  • Premium 

As a policyholder, you’ll need to make a premium payment to your insurance provider. Like we already mentioned, a portion of this will go towards your insurance plan and the rest will be invested in a fund or combination of funds of your choice. Your premium will be determined by a number of factors like your sum assured amount, your age, your income, quantum of investment, etc., 

  • Investment Component

A portion of your premium goes towards purchasing units in investment funds. You can choose the fund that you’d like to invest in depending on your risk appetite, financial goals, etc. Generally, you’ll be able to choose between equity funds, debt funds, or balance funds. 

  • Insurance Component

A portion of your premium is also allocated towards life insurance coverage. This is known as the mortality charge. This part of the ULIP offers death benefit to the beneficiaries in case of the policyholder’s demise during the policy term. 

  • Units and Net Asset Value (NAV)

As mentioned above, a portion of the premium is used to purchase units in a selected fund. The value of these units is directly associated with the performance of the fund at a given point in time. The Net Asset Value, or NAV refers to the market value of one unit in a fund.

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Important Terms in ULIP

Here is a list of must-know terms in ULIP investments.

  • Fund Value – It is the total monetary value of the fund units owned by the policyholder.

  • Sum Assured – It is the amount guaranteed to the policyholder after the policy term is over.

  • Partial Withdrawal – The policyholder can withdraw a certain amount before the policy matures. Partial withdrawals can be done after the completion of the five-year ULIP lock-in period.

  • Fund Switch – It is a feature in ULIP that allows policyholders to switch between investment funds. With this, you can switch from equity to debt and vice versa as per the market performance of your investment. Check with your insurer whether fund switching is chargeable or not before availing the feature.

  • Top-up Premium – It is an additional amount that you can pay over and above your existing premium amount.

  • Premium Payment Term – You can choose to pay ULIP premiums either as single-premium payment or as regular premium payment. In single-premium payment, you pay a lump sum amount together. Whereas, in regular premium payment, you get to pay premiums at regular intervals.

  • Policy Surrender – This means you want to exit the plan before the policy matures.

  • Surrender Value – It is the amount you pay in the event of policy surrender.

  • Maturity Benefit – It is the amount you receive in the event of policy term completion.

  • Death Benefit – It is the amount your beneficiaries receive from the insurer in case of your sudden and unfortunate dismissal.

  • ULIP Charges – These are the charges levied by the insurer. We have discussed ULIP charges in detail in the section below.

Types of ULIP Categorised by Risk and Investment Objectives

The ULIP funds are categorised based on their risk and investment objectives. The four categories of ULIP funds include:

  • Equity Funds

Here, the primary investment made is in company stocks and equity. Equity-oriented funds are high-risk funds and are best-suited for investors with a high-risk appetite. According to the thumb rule, high-risk investments earn high returns. However, the primary aim here is capital appreciation.

  • Income and Bond Funds

Here, the funds are invested in fixed income instruments, government securities and corporate bonds. These ULIP investments offer moderate risk and return.

  • Balanced or Asset Allocation Funds

These funds are one of the most stable amongst all. These ULIP funds are basically a combination of equity-oriented funds and fixed interest instruments. The invested capital is distributed between the high-risk equities and low-risk funds.

  • Cash Funds

These are also known as money market funds or liquid funds. Here, your invested capital will be dedicated to low-risk money and short-term market instruments such as bank deposits, treasury bills, and commercial paper.

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Types of ULIP Categorised by Death Benefits

Types of ULIP Plans can be broadly divided based on death benefits paid out:

  • Type-I ULIP

Under the Type-I ULIP plan, the nominee gets the Sum Assured or Fund Value as the death benefit. In case the policyholder dies during the initial years of the policy when the fund value is relatively lower than the sum assured, the insurer will pay the sum assured to the nominee.

 

However, when the fund value is higher than the sum assured, the fund value is offered as the death benefit to the nominee. In simple terms, Type I ULIP plans offer either the Sum Assured or Fund Value, whichever is higher as the death benefit.

  • Type-II ULIP

Under the Type-II ULIP plan, the nominee gets both the Sum Assured and Fund Value as a death benefit in the event of the demise of the policyholder. Hence, Type-II offers a more considerable death benefit as compared to a Type-II ULIP plan.

 

However, the premium for the Type-II ULIP plan is relatively higher as the insurance company assumes higher risk from the policyholder.

What is ULIP and how does it work?

What is ULIP

Let’s have a quick recap on what ULIP is and how the policy works.

Features of ULIP

The most convenient feature of ULIP is the policy’s premium payment method. Here’s a walkthrough on the same.

  • Single-Premium Payment: You are liable to pay the entire ULIP premium as a lump sum amount in one go. This is usually done at the start of the policy term.

  • Regular Premium Payment: Here, you have to pay a predetermined premium amount regularly (annually, monthly, quarterly), depending on the term opted.

  • The Number of Premium Paying Years: Ideally, the policy term and the years of premium payment is the same in ULIP. However, most insurers in India allow you to decide the number of premium payment years at the time of policy purchase.

Benefits of a ULIP

  • Tax Benefits

 The premium paid on ULIP investments are eligible for tax deductions under Section 80C of the Income Tax Act, 1961. An amount up to ₹1.5 lakh paid as annual premium is exempted from tax.

Further, the maturity benefit is also exempted from taxes under Section 10 (10D). Read more about ULIP tax benefits at Bajaj Markets to understand why this is a great investment avenue.

  • Flexibility

ULIP plans help you meet your financial goals. You can invest in equity funds, debt funds, or a combination of the two. However, ULIP plans also give you the flexibility to switch from equity to debt and vice versa.

So, in case you feel that your investment portfolio is not producing desired returns, you can make changes to it and hope to yield high returns.

Moreover, you can invest additional capital over and above your existing premiums. This can be done as and when needed, depending on your financial conditions.

  • Transparency

Important indicators like charge structure, the value of the investment, and the expected rate of returns, will be shared by the insurance company before you buy a ULIP plan.

  • Liquidity

With ULIP plans, you get an option of partial withdrawal in the policy. With this option, you can manage emergency expenses, family vacations, a child's education, and more. Generally, the partial withdrawal option is free and can be availed after the lock-in period is over.

  • Market Linked Returns

You also enjoy high profits from market-linked ULIP returns. This is possible because a portion of your premium is invested in funds of your choice. These funds could be either equity-oriented, debt funds, or a combination of the two.

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ULIP Lock-In Period

The Insurance Regulatory and Development Authority of India (IRDAI) has made several changes in ULIP terms and conditions since 2010. One of the significant changes made to the policy was to increase the lock-in period from three years to five years. Since ULIP is primarily an insurance product, staying invested in it for a longer duration is beneficial for the investors. Therefore, a minimum of a five-year lock-in period will help you reap reasonable ULIP returns.

ULIP Charges

Here are a few ULIP fees and charges that you need to be aware of before investing in the policy.

  • Fund Management Charges – These are the expenses incurred when managing your funds. Generally, they are charged as a percentage of the fund’s value and are deducted before the Net Asset Value of the fund is derived.

  • Discontinuation Charges – This fee is applicable if the policyholder decides to discontinue the ULIP scheme before the lock-in period of 5 years is over.

  • Mortality Charges - This charge is levied monthly as compensation for the insurance company in case a policyholder does not live up to the assumed age.

  • Surrender Charges – This fee is applied in case of premature full or partial withdrawal of units. These charges are a percentage of the fund value and depend on the year in which the ULIP policy is surrendered.

  • Premium Allocation Charges – This fixed amount is deducted from the premiums paid. Generally, premium allocation charges are higher in the initial years of the policy. However, the amount may vary depending on whether the policy is a single premium plan or a regular plan, the amount of the premiums paid, premium frequency, and payment mode.

  • Policy Administrative Charges – This amount is charged for the administration of your policy every month. Generally, they are deducted by canceling units proportionately from the fund you have chosen to invest in.

  • Fund Switching Charges – Depending on your financial goals, you can switch between the funds. Your insurer gives you a fixed number of switches for free. Otherwise, each switch is chargeable, and these charges are deducted by canceling units proportionately from the fund you have chosen to invest in.

  • Partial Withdrawal Charges - ULIP allow a partial withdrawal facility after the completion of the five-year lock-in period. While some insurers offer unlimited partial withdrawals, some restrict this facility to up to 2-4 free withdrawals. It is best to check with your ULIP provider regarding the same.

 

You can read more about ULIP Charges and fees on Bajaj Markets. Besides, if you are now keen on buying a ULIP, consider the following factors that will encourage you to make an informed decision

Things to Consider as an Investor

Here are a few things that you can keep in mind before investing in ULIP.

1. Your Personal Financial Goals

If your primary financial goal is to build wealth over time and have sufficient funds by the time of retirement, ULIP should be your go-to investment strategy. To choose the type of ULIP that will fulfil your needs, answer these few questions:

  • What are your future financial goals?

  • What is your current financial situation?

  • What are your expenses?

  • Do you have any other savings?

Answers to these questions will allow you to understand your financial requirements, based on which you will be able to select the right ULIP investment.

2. Compare Existing Options 

Once you know your financial goals and the type of ULIP investment that will help you accomplish the same, the next thing to do is intensive market research. Today, several insurers provide the same type of ULIPS, making it all the more imperative to select the right and trustworthy provider.

You can compare the ULIP from different providers based on the policy cost, premium payment options, features and benefits, fund performances, etc. Also, consider the ULIP return rate usually provided by the insurer.

3. Risk Factor

It is imperative to note that since ULIP are not diversified, the risk involved in the investment component of the policy is high.

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Withdrawal Rules in ULIP

ULIP gives you two withdrawal choices:

  • Withdrawal Before Completing the Lock-In Period

Every ULIP comes with a five-year lock-in period. So, ideally, you cannot make any withdrawals from your policy until the completion of this lock-in period. However, if you make a partial withdrawal or wish to take the entire amount invested in ULIP by surrendering the policy or not paying the premium, you still won't be able to access your cash until the lock-in period is not over.

  • Withdrawal After Completing the Lock-In Period

You can withdraw money from ULIP after completing the five-year lock-in period. However, some terms and conditions are applicable on these withdrawals. These include:

  • Limit on Withdrawal Amount: If you withdraw a significant amount from your ULIP, chances are that your life insurance cover will be terminated. Additionally, the withdrawal limits may differ from insurer to insurer. Some permit withdrawal of up to 10% of the premium paid, while for a few others, this can be up to 20%. The limit can also depend on the fund value post-withdrawal.

  • Withdrawal Rules for ULIP Top-Ups: Those who opt for ULIP premium top-ups and then plan to withdraw an amount know that the insurer will settle the same from the top-up amount. However, note that the withdrawal amount is not settled from the top-up if the policy is yet to complete its lock-in period.

ULIP vs Mutual Funds vs PPF

Here’s an explainer on ULIP, mutual funds, and PPFs. This should help you understand these three financial instruments a little better while also helping you identify which of these would best suit your financial needs. 

 

Unit-Linked Insurance Plan (ULIP)

Mutual Funds

Public Provident Fund (PPF)

Nature of Product

Combination of life insurance and investment

Pure investment

Government-backed savings scheme

Coverage

Provides life cover that is a minimum ten times the premium amount

Does not offer a life cover

Does not offer a life cover

Tax Benefits

You can avail income tax deductions on the premiums paid under Section 80C of the Income Tax Act, 1961.

Also, the maturity amount is tax-free under Section 10(10D).

Note: ULIP issued after February 1, 2021, will be treated as capital gains if the annual premium paid is more than ₹2.5 lakh. Such policies will be taxed at 10% on maturity

Only Equity-Linked Savings Scheme (ELSS) mutual funds allow you to avail tax deductions of up to ₹1.5 lakh under Section 80C of the Income Tax Act, 1961

In PPF, an amount of up to ₹1.5 lakh invested in a single financial year can be claimed for deductions under Section 80C of the old income tax structure

Flexibility

Flexibility of choice when switching between funds

No such flexibility offered

No such flexibility offered

Returns

ULIP returns depend on the type of funds you choose to invest in and the performance of the underlying markets

Mutual fund returns depend on fund allocation in conjunction with the market performance

PPF is known to provide fixed returns every year. The interest rate is decided by the Indian government at the start of each financial year. Currently, PPF has an interest rate of 7.1% (2021-22).

ULIP Income Tax Benefits

ULIP investments provide several features and benefits that you can avail. However, the highlighting factor of the instrument is its tax benefits. Along with building your wealth over time and securing your family’s financial future, ULIP allows you to save money on tax.

Here’s a quick overview of ULIP tax benefits:

Tax Benefit on ULIP Premiums

The premiums paid towards your ULIP investments can be claimed for tax deductions under Section 80C of the Income Tax Act, 1961 (old income tax structure). The maximum amount you can claim as a deduction under this section is ₹1.5 lakh.

Tax Benefit on ULIP Maturity

If all ULIP premiums are paid on time, you do not pay any tax on maturity (for policies issued before February 1, 2021) under Section 10(10D) of the Income Tax Act.

However, for ULIP purchased after February 1, 2021, the scenario is different. If the aggregate annual premium exceeds ₹2.5 lakh, the maturity benefit will be taxed as a capital asset as stated in the Union Budget 2021.

Tax Benefit on Partial Withdrawals

Once the five-year ULIP lock-in period is complete, you can make partial withdrawals. These withdrawals are tax-free under Section 10(10D) of the Income Tax Act.

Moreover, the premium payable to the sum assured should not exceed 10%, and the partial withdrawal amount should be less than or equal to 20% of the fund value.

Tax Benefit on Payouts in the Event of Death

In case of your unfortunate death, your family will receive the entire sum assured or the total fund value (whichever is higher). This payout is completely exempt from tax.

Tax Benefit on ULIP Top-Ups

Another great feature of ULIP is that the policy allows you to increase your investment with top-up premiums. As such, you can invest any surplus cash in ULIP and save money on tax. That’s because these top-ups are eligible for tax deductions under Section 80C of the old income tax regime.

Long-Term Capital Gains (LTCG) Tax Benefit

LTCG tax came into the picture with the Union Budget 2018. It is applicable on capital gains exceeding ₹1 lakh from equity investments (including ELSS). Thus, if you invest in equity-oriented funds through ULIP, you can avail this tax benefit.

FAQs on ULIP

Is ULIP a good investment?

For long-term financial goals and wealth creation, ULIP is an ideal investment instrument available in the market. Also, since the money invested in ULIPs is compounded, the net returns are relatively more, thus making ULIP a good investment option.

Is the ULIP maturity amount taxable?

No, ULIP maturity amount is exempted from tax under Section 10(10D) of the Income Tax Act, 1961. Thus, you will either receive the assured benefit or the value of the unit-linked investments, whichever is higher.

When can I withdraw my ULIP?

With a standard ULIP plan, you have a withdrawal limit of 10% of the total premium amount. Sometimes, this limit is 20% of the premium amount. However, withdrawals are possible only after you complete the five-year lock-in period.

Are ULIPs safe?

Yes, if you choose a safer route to make the investments that give relatively good returns, it is secure to invest in ULIPs. However, high returns are acquired only on equity-oriented funds which are a risky investment for the young investors.

Can I terminate my ULIP?

If you plan to terminate your ULIP investment before the completion of the lock-in period, then you will have to pay surrender charges. However, you receive the payout only after the lock-in period is over.

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