Mistakes you must avoid while buying a ULIP

Mistakes you must avoid while buying a ULIP

ULIP stands for Unit Linked Insurance Policies combining the investment and insurance needs of a person. ULIPs have become extremely popular among investors as a great tool for tax saving and wealth creation.

A ULIP provides a reduction in taxes, a life cover, and an appreciation in the invested amount.

People who want to gain substantially from ULIPs should invest in it for a minimum of 10 years. ULIPs provide the best results only when one is investing in it from a long-term benefit. Also, one cannot rely only on a ULIP to fulfil their insurance needs. It is important that you avoid the following mistakes while buying a ULIP.

Do not invest only for the tax-benefits

ULIPs are eligible for tax benefit under section 80C of the Income-tax Act. It is considered one of the products for INR 150,000 tax deduction. Many people buy ULIPS only because it is a section 80C option and helps in reducing taxes.

If you want the tax-benefit, you cannot withdraw the invested amount for a period of 5 years from a ULIP. Where you withdraw money before 5 years, you have to pay taxes on the money received. Thus, you must look at the long-term benefit before making a decision of investing in ULIPs.

Do not invest only for a life cover or insurance

A general ULIP with a premium of 1 lakh INR per annum will provide you with the insurance cover of INR 10 lakhs. This ULIP is for a period of 10 years. Thus, the sum assured is equal to the amount that you would pay a premium per annum for the ULIP.

Before rushing into buying a ULIP for the purpose of insurance, just think if the sum assured of INR 10 Lakhs is enough for your family? Will it actually serve the purpose of insurance? You can refer our Article – How much cover you need in term insurance. This shall help you understand what amount of cover you actually need and how pure term insurance is the best product for your insurance needs. Do not substitute the same with ULIPs.

Also, if you stop paying the premium amount, you lose on your insurance benefits.

Do not invest only for equity growth

ULIP is also a fund which is eventually invested in various financial products. ULIP gives you the option to select the kind of fund (i.e. pool of investment products) that you desire to invest into. Thus, you must decide based on your risk appetite, your understanding of the fund or your financial advisor's advice. Refer to Article - different kinds of ULIP funds_

Your investment decisions must be based on your defined goals and should never be a random allocation.

Do not stop paying premium after the first premium or anytime later.

Where you stop making the premium payments for your ULIPs, the following things may happen:

You will not be able to withdraw the amount until the lock-in period of 5 years.
If you stop paying your premium after the first year and withdraw the amount after the lock-in period, you do not get paid on the basis of the Net Asset Value of the year in which you are getting paid. Rather the money you get is based on the Net Asset Value of the year in which you stopped paying the premium.
The amount that you would receive after completion of 5 years would be after deducting various charges like fund management, annual charges, and surrender charges.
The insurance cover would be stopped immediately and there would be no life cover.
The death benefit will be limited to the NAV (Value) of the Fund/Money invested.

Do not overlook the charges

There are many charges in a ULIP like premium allocation charges, fund management charges, mortality charges etc. These can amount to easily 4%-5% of the premium amount invested in a ULIP.

After reading this article, you may feel that ULIPS are not a good investment option. It is not so. However, there are many things that one must look at before making an investment decision which includes things you must do and things you must not do.

What are the different funds in a ULIP and why to switch between them?

Most Insurers offer a wide range of funds to suite’s one’s investment objectives, risk profile and time horizons. Different funds have different risk profiles and thus, varied returns.

We have listed below some common types of funds that are available:

Sr. No	General Description	Nature of Investments	Level of Risk
1.	Equity Funds	Invests in equity shares of the companies listed on the stock market. This may be further split into small-cap Equity, Mid-cap equity and Large-cap Equity	High
2.	Debt Funds/ Interest Income Funds	Invested in corporate bonds, government securities and other fixed income generating instruments	Medium
3.	Cash Funds/ Money Market Funds	Invested in cash, fixed deposits or other money market instruments which are liquid.	Low
4.	Balanced Funds	They are a combination of Equity and Debt i.e. a balance between Equity and debt.	Medium to high

The funds of a ULIP are similar to the various fund classification of a mutual fund. It is due to the basic nature of both the investment products. However, it is not that easy to switch between mutual funds. Refer our Article on how to switch between mutual funds.

ULIPs are favorable due to the option to switch between different funds as per our needs and requirements. The primary objective of switching funds is to leverage from the funds performing well. If your funds in your portfolio are not performing well then the peers, you may choose this option.

There is a basic cost involved in switching of funds which depends on the ULIP that you own. Some ULIPS, allow one transfer free and anything beyond that has a fixed cost. Refer our Article - Various Charges associated with a ULIP.

Also, many people make use of switching to meet their goals and make the most of the tax benefit. You may refer to our Article ----

To ensure that you make the most of this option, you must keep a track of the funds’ performance to make an informed decision.

Asset Allocation: You must switch to re-balance your portfolio, to maintain your asset allocation or to make the most of a sudden change in the market condition. This change in market condition may also require you to review your asset allocation. As discussed for this purpose switching is cheaper than selling and re-investing mutual funds.
Life stage Needs / goal-based approach: when a switch is required to achieve your goals set in mind, you must do the same using this option in ULIPS. For example, if you have invested for a 10-year long-term goal in an equity-based fund. Based on the rules of goal setting, from the 7th year, you should start switching your fund to a debt fund to not lose the gains made in an equity fund. Such a switch is cheaper and more convenient with a ULIP than with a Mutual Fund.

Since ULIPs are long-term market-linked plans, you should review and manage them appropriately to optimize your asset allocation, minimize the risk and maximize your returns. If you are not confident about managing it yourself, it does mean that you should lose the opportunity of growing your own wealth. You can always take advantage of the auto-manage options offered by the insurer or appoint a financial advisor who shall do the same for you.

To learn more - you can check our course - NM 102: Build a Safety Net. Use code SAVE20 for 20% off.

Equity / Insurance / Investments - 08/03/2018

Charges or cost of a ULIP

ULIP is a combination of a life insurance product and an investment product, which provides risk cover for the policyholder along with investment options to invest in any number of qualified investments such as stocks, bonds or mutual funds. As a single integrated plan, the investment part and the protection part can be managed according to specific needs and choices.

ULIP is catering to the insurance and the investment needs of a person and thus, is not a cheap product. There are various costs associated for both these facilities which make ULIP a comparatively expensive product in case of short-term investments.

The list of charges that are levied in case of ULIP investments are as under:

Premium Allocation Charge

Premium Allocation Charge is deducted as a fixed percentage from the premium paid in the initial years of the policy, it is charged at a higher rate. The charges include the initial and renewal expenses and intermediary commission expenses. It is a front load charge as it is deducted from your premium paid.

Mortality Charges

This charge is to provide for the insurance coverage under the plan. Mortality charges depend on a number of factors like age, sum assured, etc and are deducted on a monthly basis. These are for the Insurance part of the product.

Fund Management Charge

Fund Management Charge is charged by the company to manage various funds in the ULIP. It is levied for management of the funds and is deducted before arriving at the NAV. The maximum allowed is 1.35 percent per annum of the fund value and is charged daily. Generally, insurers levy the maximum allowed in equity funds, while the charge on non-equity funds is lower. These are for the Investment part of the product.

Partial Withdrawal Charge

ULIPs have options for partial withdrawals of funds. Some plans offer unlimited withdrawals, but some restrict it to 2-4 withdrawals. These withdrawals can be for free up to a certain limit or can be charged based on your transactions.

Switching your funds

Moving funds or investments between options is called switching. There are options to switch your funds for free up to a certain limit per year. Any further changes might incur a charge of INR. 100 -INR.250 per switch. This is to manage your investments.

Policy administration charge

This charge is levied for the administration of the policy and it is deducted on a monthly basis by the cancellation of units from all funds chosen. This charge can be at a fixed rate or a percentage of your premium. These are for the insurance part of the ULIP.

The only free benefit of the ULIP is the tax benefit that you get when you invest in ULIP under section 80C. However, for that, you must stay invested for a period of 5 years. If you withdraw any time before that, the amount withdrawn would be taxable.

As an investor, it is very important that you know where your money is going. Many times you expect that after appointing an insurance agent for your investment needs all your investment worry is over, that may not be the case and the agent would continue selling you expensive investment products. You must learn and understand where your money should be invested to make the most of it. where you do not have the time to do so, appoint a financial advisor for yourself.

To learn more - you can check our course - NM 102: Build a Safety Net. Use code SAVE20 for 20% off.

Insurance / Investments - 08/01/2018

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