Attractive though they are, scrutinise costs before you invest in Ulips

After the recent run up in equity markets, it would be prudent to opt for a mix of equity and debt funds

The demand for unit-linked insurance plans (Ulips) is on the upswing. A recent survey conducted by Bajaj Allianz Life Insurance found increased affinity among respondents towards Ulips. Other insurers, too, have witnessed higher demand for this product in recent times.

The key factor driving demand is the buoyancy in equity markets. “The performance of equity markets over the past months has led to renewed interest in Ulips,” says Bharat Kalsi, chief financial officer, Bajaj Allianz Life Insurance. He adds that with interest rates within the economy at low levels, investors are looking for alternatives that can help them beat inflation, and that has led to many gravitating towards Ulips.

Traditionally, the high charges levied by Ulips had made them unattractive. Starting from October 1, 2013, the insurance regulator capped the charges that insurers could levy. Since then competition has driven these charges even lower. “Today Ulips offer customers a cost-effective route to save systematically for their long-term financial goals,” says B Srinivas, head of products, ICICI Prudential Life Insurance.

Ulips allow customers to choose from various types of funds. “The customer can switch from one fund of the insurer to another. Many insurers offer the auto rebalancing feature also wherein money is automatically shifted to a debt fund closer to maturity,” says Sanjay Tiwari, director–strategy, Exide Life Insurance. He adds that investors can be well asset allocated by allocating a certain percentage of their premium to various types of funds.

The tax benefit available on Ulips under Section 80C also enhances their attractiveness.

Limited flexibility

While Ulips have become more attractive than they were earlier, they are still less flexible than a combination of term plan and mutual funds. “When you buy a bundled products such as this, you do not have the flexibility to change your insurance cover, especially when you want to reduce the cover,” says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisers. As a person's net worth increases, his dependence on life insurance cover goes down.

Another issue arises if the fund underperforms. “You can only move from one fund of the insurer to another. Until the five-year lock-in in a Ulip ends, you cannot move to another manager with a better performance,” adds Dhawan.

Withdrawal of money from your fund before the end of the five-year lock-in is also not possible. And if you cannot contribute the annual premium due to shortage of funds, that has consequences.

Some investors may go for Ulips

Despite their shortcomings, Ulips make sense for certain types of investors. “Some investors find it difficult to save voluntarily. Ulips are a suitable product for them due to the need to pay the premium compulsorily,” says Dhawan.

Even though term plans are best suited for covering the risk of premature demise, some investors are loath to invest in them. They are averse to buying a product that will pay them nothing if they survive its tenure. Such customers may opt for a Ulip, where they will get some insurance coverage at least.

Pay heed to costs

In the past, two charges have been particularly high in Ulips – premium allocation charge and policy administration charge. Prospective buyers should ensure that these charges are low in the policy they plan to buy. At the same time, it should not happen that a policy has low premium allocation and policy administration charge but makes up for this by levying a high fund management fee. Ulip investors also have to bear a mortality charge.

“The sum total of all fees in Ulips can range from 1-5 per cent of the premium, so it is important to double check how much you will have to pay,” says Indraneel Chatterjee, co-founder, Renewbuy.

Adds Dhawan: “Ensure that the sum total of the three costs— premium allocation, policy administration and fund management— is in the range of 1-1.5 per cent per annum.”

While a certain number of switches may be free in a year, those beyond the specified limit may have to be paid for. Investors should be aware of this.

Besides cost, investors must evaluate the past performance of schemes offered by various insurers while choosing a Ulip.

Long investment horizon is a must

Investors should ideally enter Ulips with a horizon of 5-10 years or more. “Historic data has shown that the returns are healthy when investments are made with a long-term perspective,” says Kalsi.

At all costs, avoid relinquishing the policy before three years. “The policy will only acquire a surrender value if you have paid the premium for three years,” says Chatterjee. He, too, suggests staying invested for at least 10 years plus, to amortise the fees paid in the early years.

Investors entering Ulips now should avoid recency bias. Since the equity market has turned in a robust performance over the past year, investors should not extrapolate that performance into the long run. In fact, after such a massive run up, there is always the possibility of a market correction. “Investors will be better off with an allocation to both equity and debt funds at this point, instead of investing in an equity fund alone,” says Dhawan.

Ulips also require constant monitoring. If the fund that you have invested in underperforms, look for better alternatives from the same insurer (most offer several funds). You should also keep an eye on your asset allocation. If you believe that the equity markets have become grossly overvalued, book some profits in your equity fund and move to a debt fund.

You also need to be watchful as you move closer to your investment goal. Around two or three years prior to the goal, start moving money from the equity fund to a debt fund, so that a sharp correction in the equity markets does not jeopardise your goal.

Finally, when selecting a low-cost Ulip, also evaluate the convenience offered by the digital platform of the life insurer. “You should be able to conduct transactions such as switching from one fund to another, accessing fund value, receiving receipts for premium paid, and even raising a claim digitally,” says Srinivas.

Understanding how Ulips are taxed

If issued on or after February 1, 2021:

• If the policy premium does not exceed Rs. 2.5 lakh per annum, Section 10(10D) of the IT Act will apply, which provides an exemption to any sum received from a life insurance policy (including Ulip), provided the premium payable for any of the years during the policy term did not exceed 10 per cent of the sum assured.

If issued after April 1, 2012 but prior to February 1, 2021

Any sum received from the policy will be exempt under Section 10(10D), if the premium payable for any of the years does not exceed 10 per cent of the sum assured. The new condition of premium not exceeding ~2.5 lakh per annum will not apply to these policies.  

If a policy is not covered by Section 10(10D)

Then the tax implication will depend on the nature of the Ulip fund.

• Equity-oriented fund (at least 65 per cent of assets in direct stocks, or at least 90 per cent of assets in case of indirect equity investment): The gains derived from Ulip will be taxed as capital gains with 12 months as the threshold holding period. 
• Short-term capital gains (holding period less than 12 months) will be taxed at 15 per cent under Section 111A
• Long-term capital gains (if holding period exceeds 12 months) will be taxed at 10 per cent under Section 112A, with exemption for Rs 1 lakh.

Taxation of non-equity Ulips

They will get tax treatment similar to a debt fund.

• Threshold holding period will be three years.
• Long-term capital gains will be subject to tax @ 20 per cent under Section 112 after providing indexation benefit.
• Short-term capital gains will be taxed in accordance with the investor’s slab rates.   

Source: RSM India

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