ULIP – Unit Linked Insurance Plan

How ULIPs work?

• In a unit linked plan, the amount of premium that you want to pay is decided by you. The insurance company prescribes the minimum amount of premium required to buy its ULIP. You can, thereafter, choose to invest the minimum premium or any amount which you like as long as it is more than the minimum level.
• The premium also determines the sum assured of the plan. In case of ULIPs, sum assured is determined as a multiple of the premium paid. The multiple depends on the insurance company and its plan.
• The premium that you pay is then invested in a choice of investment fund. There are, basically, three types of investment funds which are available. They are as follows –

• Equity fund – under this fund, at least 65% of the portfolio is invested in equity and equity oriented securities. Since the fund invests primarily in equities, the return potential is very high. However, given the volatile nature of the equity market, there is also a very high risk in equity funds.
• Debt fund – debt funds are those which invest primarily in debt instruments and securities which have a fixed rate of return. Since debt instruments are fixed income instruments, debt funds have very low market risk and are relatively safe. However, the return under debt funds is also low.
• Balanced fund – balanced funds combine equity and debt investments. Half of the portfolio of the fund is invested in the equity market while the other half is invested in debt. This fund, therefore, has moderate risks and also gives moderate returns.

You have the flexibility of choosing the fund into which you want to invest your premiums. You can invest the premium in any one or more of these funds as per your investment strategy.

• The premium is then invested in the fund based on the fund’s Net Asset Value (NAV). NAV represents per unit cost of the fund. It is fund calculated using the following formula –

NAV = Total market value of investments of the fund’s portfolio / number of securities bought by the fund

Based on the NAV you get specified units of the fund which you select.

• Charges are deducted from the fund value for different services offered by the plan.
• There are other flexible features like partial withdrawals, switching, premium redirections, top-ups, etc. which give you complete flexibility of investing and maintaining your investments in the unit linked plan
• There is a lock-in period of 5 years. During these five years, withdrawals from the plan are not permitted. However, once the lock-in period of 5 years is over, you can freely make withdrawals as and when needed.
• When the plan matures, the available fund value is paid to you
• In case of death during the policy tenure, higher of the sum assured or the fund value is paid as the death benefit. However, almost all unit linked plans guarantee a minimum of 105% of total premiums paid in case of the death of the life insured.

Types of ULIPs

ULIPs are mainly of three types which are as follows –

Under these plans, the primary objective is wealth creation. You choose the plan tenure, the premium amount, the sum assured and the investment fund. You pay the premiums which are invested in the chosen fund and then you can let your investments grow.

Child ULIPs are child insurance plans whose main aim is to create a corpus for the child even if the parent is not around. Under these plans, insurance cover is, usually, on the life of the parent. If the parent dies during the term of the plan, the plan does not terminate. There is an inbuilt waiver of premium rider due to which the future premiums of the plan are waived off and the plan continues till maturity. The insurance company pays the premium on behalf of the deceased parent. Thereafter, when the plan attains maturity, the fund value is paid. Child ULIPs, therefore, help in creating a corpus for the child’s future through market linked growth.

Pension ULIPs are life insurance deferred annuity plans. You buy a plan with a specific term. During the policy term premiums are payable which accumulate into a corpus with market-linked returns. Once the term of the plan is over, the accumulated corpus is then used to buy annuities. Annuities are regular incomes which are paid to the policyholder till his lifetime. Thus, pension ULIPs create a substantial retirement fund and help in generating income after retirement.

Unique features of ULIPs

ULIPs are different from other life insurance plans because they provide you with various unique benefits which make the plan very flexible in nature. These unique features are as follows –

Partial withdrawals allow you to withdraw from your fund value partially. After the lock-in period of 5 years is over, your fund value can be used for meeting urgent financial needs. Through partial withdrawals, ULIPs allow you easy liquidity. There is a limit to the amount of partial withdrawal which you can do from your fund value. Usually, ULIPs require you to maintain at least one annualised premium in the fund value at all times after doing a withdrawal.

Switching means to transfer your invested premium from one fund to another. Once you choose a fund for investing your premium, the choice is not fixed in nature. You can change investment funds whenever you want through the switching facility. Switching, therefore, lets you change investment strategies as per market movements. For instance, if you have invested in debt funds and the equity market is growing, you can switch your fund value from debt fund and transfer it to equity fund to bank in on the growth. Similarly, if the equity market is volatile and you want to protect your investments, you can switch your investment from equity fund to debt fund. Switching is allowed without any limits.

Top-up is an additional premium, over and above the actual premium paid under the plan, which you want to invest in your unit linked plan’s fund. When your ULIP is giving you very good returns, you might want to increase your investments to generate higher returns. Top-ups allow you to increase your investments through the payment of additional premiums. Moreover, every top-up that you make in your unit linked plan would also have a sum assured. Thus, top-up investments would also increase your plan’s aggregate sum assured level as well as fund value.

Premium redirection is like switching but with a difference. While in switching you take out your investment from one fund and transfer it to another, in case of premium redirections, future premiums are redirected to another fund. Thus, the earlier premiums which were paid continue to remain invested in the funds which you selected earlier. Only new premiums are redirected to be invested in another fund.

Settlement option is allowed when the plan matures. Through the settlement option the policyholder is given the choice to avail the maturity proceeds in five equal instalments over five years after maturity. So, if the fund is performing well and you want to continue to remain invested in the plan, you can choose to take the maturity value in instalments leaving the fund value in the fund to grow over the next five years.

Charges under ULIPs

As stated earlier, various charges are deducted from the fund value in a unit linked plan. These charges include the following –

This is the first charge which is deducted from the premium before it is invested in any fund. The premium allocation charge represents the commission paid to the insurance middleman for selling the policy and bringing in the premium. The premium allocation charge is the highest in the first year and thereafter reduces in subsequent years. After a few years, the charge becomes nil.

This charge is deducted for maintaining the policy. Administrative charges are directed from the fund value every month.

The fund in which the premium is invested is managed by expert fund managers so that the investment can reap maximum returns. These fund managers are paid a fund management fee which, in turn, is deducted from the fund value in the form of fund management charges

This charge is deducted for the insurance cover provided under the plan. The mortality cost covers the death risk and is deducted from the fund value.

Unit linked plans have a lock-in period of 5 years. If the plan is surrendered during the lock-in period, discontinuation charges would be levied. The charge would be deducted from the fund value and the fund value would be transferred to a discontinued policy fund. The fund value would remain in the discontinued policy fund till the completion of five years after which the value would be paid to you.

Besides these common charges, there are other charges which might be levied which include the following –

• Partial withdrawal charge on partial withdrawals
• Switching charge
• Premium redirection charge
• Charge for issuing a duplicate policy, etc.

Tax implications of investing in ULIPs

ULIPs, like any other life insurance plans, give tax benefits. These benefits are as follows –

The premiums that you pay for the unit linked plan are allowed as a deduction under Section 80C. The limit of deduction under Section 80C is up to INR 1.5 lakhs. Premiums paid for pension ULIPs qualify under Section 80CCC. The limit under Section 80CCC is also INR 1.5 lakhs including Section 80C limit. However, for premiums to be eligible as deductions under Section 80C or 80CCC, the following parameters should be fulfilled –

• The premium should be up to 10% of the sum assured. If the premium is more than 10% of the sum assured, deduction is allowed only up to 10% of the sum assured subject to a maximum of INR 1.5 lakhs
• The policy should not be surrendered within the first 5 years of buying the policy

If the policy is surrendered after the completion of the first 5 years of the policy, the surrender value received is completely tax free.

The maturity benefit received is completely tax free in your hands under the provisions of Section 10 (10D). However, the sum assured should be at least 10 times the annual premium. For instance, if the premium is INR 1 lakh, the sum assured should be INR 10 lakhs and above for the maturity benefit to be tax-free under Section 10 (10D). If the sum assured is not up to at least 10 times the premium, the entire maturity benefit would be taxable in your hands. So, in the example, if the sum assured is below INR 10 lakhs, the maturity proceeds would be taxable at your slab rates in your hands.

The death benefit, however, is completely tax free if the insured dies during the term of the plan. In case of death benefit the sum assured need not be at least 10 times the annual premium. Whatever benefit is paid by the insurance company would be tax-free in the hands of the nominee.