In the first three years, the fund value of a ULIP may remain low due to the high expenses such as administration charge, fund management charge, premium allocation charge and mortality charge deducted initially
Initially, the insurance market was ruled by traditional products such as term and endowment plans. With the opening up of the sector, buying a life insurance policy came up with more options in the form of unit linked insurance plans (ULIPs). ULIPs basically provide protection and also aim to accumulate wealth. Here are a few things which you should know about ULIPs:
What sets ULIP apart from the traditional insurance policies is its ability to blend investment and insurance in one single plan. A ULIP invests a certain portion of your premium in the capital market depending on your risk profile through its various fund options.
Key advantages of ULIP
- Insurance cover
- Tax benefits under Section 80C
- Gives you a range of investment options to choose from depending on your risk profile
How does a ULIP work?
A certain amount of premium paid—in case of a ULIP—is invested to meet your insurance meets and some amount towards building wealth.
In the initial policy years, a large part of the premium is spent on meeting policy expenses. Post deduction of these expenses, some amount of the premium is invested in life insurance to provide you life cover in case of an unfortunate event and the remaining is invested in different funds for wealth creation.
These funds could be equity, debt or a combination of both. The value of the units allocated depends on the performance of the underlying fund. In the first two to three years of the policy, the fund value may remain low due to the high expenses deducted initially.
Costs involved in ULIP
Investments in a ULIP involve expenses such as: Premium allocation charge, administration charge, mortality charge and fund management charge.
Premium allocation charge is the amount deducted from your premium payment to meet the insurer’s costs related to marketing and distribution. This charge is higher in the initial years and gradually reduces post the third or fourth year of the policy.
Administration charge is deducted on a monthly basis. It refers to the general administration costs of managing a ULIP.
Mortality charge is the cost allocated to provide life insurance cover. This is a variable charge and is greatly dependent on the mortality rate of the insured.
Fund management charge is deducted to manage your investments and is generally in the range of 0.5% to 2%.
The premiums paid are eligible for tax benefits under Section 80C where a deduction of up to Rs. 1 lakh from the taxable income of the individual is permitted. In case of policy holder’s death, the amount received by the nominee is totally tax free in the nominee’s hands. The maturity too is classified as a payout under Section 10 (10D) and the entire amount is tax free in the hands of the policyholder.
ULIPs could be surrendered prematurely; however there could be cost implications. On surrender, a percentage of the fund value is to be paid as surrender charges, depending on the scheme.
If a ULIP is surrendered in the first three years, the insurance cover would cease immediately. However, the surrender value can be paid only after three years. So though the policy acquires a surrender value before completion of three years, it is payable only after the completion of three policy years. Many insurance policies also allow part surrender or partial withdrawal after three to five years without any cost and without any reduction in the insurance coverage.
Make the most of your ULIP
Long term horizon: A ULIP is a long term investment plan. You stand to gain the most if you stay invested till maturity. They are not to be considered as short term investment vehicles to earn quick gains.
Know your objective: Your prime objective should be to have adequate life insurance cover to protect your family from unforeseen events. Work out the required life cover on the basis of your age, income and dependents.
Customise your plan: You could use the various add-on benefits to customise your ULIP depending on your requirement.
Riders: A rider with a ULIP is an additional cover along with the base policy available for an extra charge. This could be accidental death, disability benefit or a critical illness cover.
Top ups: For an additional amount over your regular premium, you could increase your investment component in the base policy. In such cases, partial withdrawals are permitted generally only after five years.
Switches: You could switch your investments from one fund to another in case of change in your risk profile depending on your age, investment objective and time duration. Five to six switches are generally not charged for, further to which you may have to pay a nominal charge.
Article contributed by MyInsuranceClub
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