Unit Linked Insurance Plans, better known as ULIPs, are hybrid products that mix life insurance with investments. Similar to other life insurance products in the market, they offer life cover along with investments. However, it is to the policyholder to make the investment choice from among the various available fund options, which then transfers the risk of investment to the policyholder. These funds can be either equity or debt-oriented, or a combination of both. And while these policies may be more profitable as compared to a traditional insurance policy, they also carry a much higher risk.
Capital and inflation protection
As long the premium is being paid and the policy is in force, the sum assured in life insurance is guaranteed as per the policy terms. Life insurance is not inflation-protected since it is a fixed cover and fixed tenure product. However, equity fund options have the potential to beat inflation and create wealth in the long term. They, however, do not guarantee inflation-beating returns.
The minimum sum assured is guaranteed, and the premium is also fixed for the tenure. Returns on the investment portion, however, are market-linked and therefore are not guaranteed.
ULIPs become liquid only after the lock-in period of five years. This liquidity can be achieved by redeeming the units in which the premium is invested. One is also entitled to make a premature withdrawal or can surrender the policy at a loss. Depending on the policy type, the years for which it has been in force, and its fund value at the given time, loans are available against it.
One is entitled to surrender or terminate the policy at a financial loss.
· Only on completion of the lock-in period can the insurer credit and refund the proceeds of the discontinued policy to the policyholder
· These proceeds for the refund to the policyholder mean the fund value as on the date of discontinuance, as well as the interest which is computed at a minimum rate of 4 percent per annum.
Premiums that are paid for a life insurance policy qualify for tax deductions under Section 80C, however, they have a limit of Rs 1.5 lakh in a financial year. Also, if the premium that is paid is more than 20 percent of the assured sum assured of the policy, the amount that is eligible for tax deduction is limited to 20 percent of the sum assured.
Bear in mind that for policies that have been issued on or after April 1, 2012, the above-mentioned limit has been changed to 10 percent. All proceeds from the maturity or claims of the policy are exempt under Section 10(10D).
Types of ULIPs
Based on the benefits they offer, ULIPs are broadly divided into three categories: Type I, Type II, and Pension ULIPs (ULPPs).
Type I ULIP: The policy will pay whatever is higher, the sum assured or the unit value of the investment to the nominees upon the death of the policyholder,
Type II ULIP: The policy will pay out both, the sum assured as well as the net asset value of the fund that the policyholder had invested in, to the nominees on the death of the policyholder. Naturally, premiums for such plans are higher than those on Type I ULIPs. These investments also come at a high level of risk.
Pension ULIPs: This ULIP combines both life insurance and retirement income. Upon the death of the policyholder, the insurer will pay the nominees the death benefit. However, if you live to retirement age, this pension plan will pay back the premiums as well as accrued returns to you in full.
Unlike traditional plans, ULIPs work the other way round. That is to say that unlike an assured sum deciding the premium, the premium that one pays will determine the extent of cover that is offered. The sum assured also varies as per the premiums paid, whether they are regular or one time.
Here is the last note that investors should keep in mind. ULIPs might seem to be the perfect solution for both insurance and investment. However, they have their limitations too. If you buy a pure term cover, on the other hand, you will not only be paying much less, but you will also be covered much better; though there are of course no returns. At the same time, you can invest in equity through MF or stocks, which will again save you the high premiums of a ULIP. This way, not just will your coverage be better, but your returns will be higher too!