What is a Unit Linked Insurance Plan? A Complete Guide

Traditional insurance policies like term plans, endowment plans, etc., only offer risk coverage. They help secure your family’s future in case of uncertainty, but do not build wealth. On the other hand, investments in equities, debt, etc., aim to grow wealth over time.

ULIPs are a hybrid product that provides both insurance and investment under a single plan. They provide life cover like a traditional policy and also the opportunity to invest across equity, debt and other asset classes for wealth creation.

What is Unit Linked Insurance Plan (ULIP)?

A Unit Linked Insurance Plan or ULIP is a life insurance policy that provides dual benefits of risk protection and investment. Here, the premium paid is invested in market-linked assets like equities, debt instruments, money market instruments, etc, as per your chosen allocation

The investment portion works just like a mutual fund. The premium gets divided into units and invested across assets. The value of these units and your fund value fluctuates based on the performance of the underlying investments. Alongside, you also get life cover for the financial security of loved ones

How ULIP Plans Work

ULIP plans have two components - protection and investment. Let’s understand both in detail:

Protection: You choose a sum assured or life cover to secure your family. A portion of the premium pays for this life cover, mortality charges and other expenses. The remaining premium gets invested.

Investment

Here’s how it works:

• You choose a fund or mix of funds to invest based on risk appetite - equity, debt or balanced.
• Each premium payment buys you units in your chosen fund(s) based on the unit price, just like mutual funds.
• The value of these units fluctuates based on the fund’s performance. Your fund value equals the total number of units multiplied by their price.
• You can switch funds, and the premium paid towards investments can be redirected.
• Partial withdrawals from fund value are allowed after the lock-in period.
• You bear the investment risk. Returns are linked to the equity markets or debt/other instruments, where you choose to invest your premium.

Key Features of ULIPs

Some key features of ULIPs are:

• Life Cover: Get life insurance cover to protect loved ones along with market-linked returns.
• Flexible Premium: Most plans allow paying premiums as a lump sum, yearly, half-yearly or monthly instalments.
• Fund Options: Invest across equity, balanced and debt funds as per your risk tolerance.
• Fund Switching: Option to switch money between funds as per changing risk appetite and market conditions.
• Premium Redirection: Option to redirect future premiums towards better-performing funds.
• Partial Withdrawals: Withdraw your fund value partially after completion of the lock-in.
• Tax Benefits*: Avail tax deductions up to ₹1.5 lakhs u/s 80C on premiums paid and tax-free withdrawal on maturity under Section 10 (10D), subject to conditions.

Benefits of ULIPs

Unit-linked plans have the following benefits:

• Dual Benefit Plans: ULIPs provide both life cover and the opportunity to earn market-linked returns on investments for wealth creation. They secure as well as help grow money.
• Flexibility: You have the flexibility to choose fund options as per your risk appetite. You can invest across equity, balanced and debt funds. As needs change, you can redirect future premiums or switch money between funds.
• Liquidity: ULIPs come with a partial withdrawal facility. After the 5-year lock-in ends, you can access your money in case of emergencies by making partial withdrawals.
• Transparency: ULIPs provide easy access to policy and fund details. You can easily track fund performance. NAVs declare fund value daily.
• Tax Benefits*: You can save taxes by investing in ULIPs in 2 ways. Premiums paid are eligible for tax deduction under Section 80C up to ₹1.5 lakhs. Maturity proceeds and death benefit also enjoy tax exemptions under Section 10 (10D), subject to conditions.
• Low Charges: ULIPs were infamous for high charges; however, new regulations have capped charges. Today, ULIP charges are very competitive, with around 2-2.5% annual fund management charge.

Who Should Invest in ULIPs?

ULIPs can be suitable for:

• Young earners: Young professionals in their career’s growth phase, looking for tax savings and wealth creation, can consider ULIPs. A long horizon allows riding the market ups and downs.
• New investors: For those new to personal investing, ULIPs provide a simple, packaged solution for insurance and investments easily.
• Aggressive investors: Equity ULIPs allow investing over 80-90% of the corpus in equity. Those willing to take risks for potentially higher returns can opt for them.
• Hands-off approach: Lazy investors who seek a packaged solution for protection plus investments without day-to-day tracking can consider ULIPs.

However, conservative investors with low risk tolerance may be better suited to traditional insurance plans combined with low-risk investments. Those seeking very short-term goals should also avoid ULIPs due to the lock-in clause.

ULIPs vs Mutual Funds vs Traditional Insurance

Let’s understand how ULIPs fare against regular mutual funds and traditional insurance plans on key parameters.

• Returns: ULIP returns are market-linked based on the fund performance selected. The returns can match or even exceed mutual funds investing in similar assets. Guaranteed traditional plans offer only 4-7% returns.
• Taxation*: ULIPs and mutual funds have similar tax treatment. Income tax benefits u/s 80C on investment and 10(10D) on maturity proceeds. Traditional plans also offer tax benefits on premiums and returns.
• Charges: ULIPs cap charges at around 2.25% annual fund management charge. MFs charge around 1-1.5%. Traditional plans allow 5% annual charges on returns accrued.
• Liquidity: MFs score highest with instant redemption flexibility. ULIPs carry a 5-year lock-in clause with only partial withdrawals post that. Traditional plans are very rigid with zero liquidity.
• Flexibility: In asset allocation and premium payments, ULIPs and MFs offer the highest flexibility. Highly rigid traditional insurance plans offer no flexibility or change options.

FAQs

What is the lock-in period for ULIPs?

ULIPs come with a mandatory lock-in clause of 5 years. During this period, you cannot fully withdraw or surrender your policy without specific permitted reasons by regulators. This ensures you continue to retain insurance cover for at least medium term.

Are ULIPs risky?

ULIPs carry the same market-linked investment risks that mutual funds do. Equity funds can be especially volatile with high short-term risks. However, long investing horizons of 10-15 years allow potential to generate inflation-beating returns. Choose your asset allocation based on your risk-taking ability.

Can I switch funds in a ULIP?

Yes, most ULIPs allow you to switch corpus from one fund to another a limited number of times per year without charges. This flexibility helps you rejig fund allocations with evolving markets or risk profiles.

Is ULIP suitable for short-term investment?

No, ULIPs are more suited to long-term goals of at least a 10-15-year horizon due to the 5-year lock-in clause plus high early exit penalties. The long term allows for potential equity exposure to deliver inflation-beating returns over market cycles.

Can I partially withdraw from my ULIP?

Yes, ULIPs offer partial withdrawal facilities after completion of the 5-year lock-in period. Regulations allow for withdrawals of up to 25% of the fund value at that time. This provides access to funds in case of emergencies or interim needs