Making most of Ulips

By any standard, Srinivasa Murty is an evolved investor. The 36-yearold Mumbai-based corporate executive picks equities that have potential. Mutual funds are chosen after studying their performance.

ULIPS DEMYSTIFIED

Work best for people aged 25-40 years Because:These are long-term products that need an investment horizon of at least 10 years to yield maximum benefits

Is a good investment after life insurance Because:They combine basic insurance with mutual fund

It could also work as entry-level mutual fund Because: It allows you to switch across funds at lowest cost

Low-cost mutual fund in the long term Because:Annual fund management charges in Ulips are around 1% compared with 2-3% charged by equity mutual fun

Allow liquidity to the investor Because:All or part of corpus can be withdrawn after 3 year

And real estate is bought to diversify the investment portfolio. But two years ago, he did something that surprised many financial planners—most of them hardcore unit-linked insurance plan (Ulip) bashers and mutual fund distributors. Murty invested in a Ulip from ICICI Prudential Life, committing a premium of Rs 2 lakh a year for the next 20 years. “This instrument inculcates disciplined long-term investing and offers good returns as well,” he says.What Murty did consciously is what a growing number of investors are doing unwittingly—investing in Ulips without knowing how and when they work best. Ulips are life insurance policies where the insurance cover is bundled with investment. Unlike traditional insurance-cum-investment policies such as endowment and money-back policies which offer very low returns, Ulips offer market-linked returns.However, to derive the full benefit of such plans, an investor needs to fully understand their structure and how they work. For instance, most insurance agents peddle Ulips by telling the investor that he is free to exit from the plan after three years. But it is only after three years that the real benefit of a Ulip kicks in. These long-term investment products have high initial charges so an early exit isn’t usually a sensible decision.

Ulips might have caught your fancy as well for all the noise insurers and agents have made over the past few years. They have also faced brickbats from many investment experts who argue that mutual funds offer better returns and more freedom to investors. These investment experts claim that a combo of mutual funds and a term plan, which offers pure insurance at a low cost, offers better returns than a Ulip.

That’s a myth that needs to be dispelled. Ulips do charge as much as 25-40% of the premium as administrative costs in the initial years but these charges usually taper down to about 1% by the fourth or fifth year. Most diversified equity mutual funds charge up to 2.5% of the corpus value as fund management fees every year. In Ulips, the charge is lower at around 1%. In the long term, say 15-20 years, this small difference in annual fund management charge can have a significant effect on your returns. For example, if we assume that a term insurance-diversified equity fund combo and the equity option of a Ulip will both earn 10% annualised returns, the ULIP with the same life cover will overtake the fund in about 10 years notwithstanding the high charges in the initial years (see graph Long-distance runner). Says Kolkata-based financial planner Brijesh Dalmia: “In the long term Ulip charges are nothing compared to mutual fund management charges.”

That is not the only compelling reason for investing in a Ulip. Just as a well chosen tax planning fund can offer you complete financial planning, a good Ulip can be your one-stop financial plan, offering everything from tax planning to life insurance to long-term wealth creation and liquidity. You get Section 80C tax benefits on the premium paid. The insurance cover is five, 10 or 20 times the premium amount. You also have the freedom to decide how much of your corpus should be exposed to equities.

Buying a Ulip? Find out...

The fees charged by different insurers Insurers levy mortality, administrative and premium allocation charges in varying combinations

How many switches in a year are free Most insurers allow up to 3-4 switches between different options in a year without levying any fee

How many top-ups allowed and the charge Insurers usually allow additional investments of up to 25% of the premium in a year

If you can increase life cover Some insurers allow this by increasing the deduction from the premium that goes into providing life cover If you can remain invested after maturity Compulsory redemption at maturity can be costly if the market is down. Opt for a plan that allows flexibility

Vivek Khanna, director (marketing) of Aviva India, says Ulips also offer flexibility to investors. They can switch from the equity option to a balanced plan or even a debt option depending on which way the markets are headed. Unlike mutual funds, insurance companies allow up to 3-4 free switches in a year. What’s more, Ulips are also tax efficient. Since Ulips are insurance plans, there is no tax on the profits made from switching even if the investment is for less than one year.

In equity funds, any profit made from switching out of a fund within one year is taxed at 10%. In debt funds, it is worse. The profit is clubbed with your income for the year and taxed at the applicable slab rate. Assuming that an investor makes a 10% profit by switching his entire corpus from equity to debt once in two years and then reverting to equities, he would significantly boost his corpus size over 15-20 years. In any case, it is a good learning ground for investors who like to tinker with their investments every now and then.

“The free switches allow investors to see the impact of buying and selling without losing much. However, I do realise that over the long term, equities always outperform other asset classes and so will my Ulip,” says Murty.

So, what type of investors should go for Ulips? Says Pranav Mishra, vice-president (products), ICICI Prudential Life Insurance: “Though Ulips are good at all stages in life, they work best for the 25-40 age group because that gives the investment a good 15-25 years to grow.” There is an additional benefit—even at the end of the tenure you can remain invested in the fund, minus the life cover. This means you don’t have to necessarily exit if the market is at a low when the policy matures. Besides the maturity benefit is tax free under Section 10D. “Ulips are a good diversification tool because you can allocate funds to different options based on your risk appetite,” adds Dalmia.

A word of caution: Ulips work best in the long term, so commit to a premium that you can comfortably invest over the next 15-20 years. Often people make a large commitment and then exit the plan when they face difficulties in paying the premium after a few years.

Assured return schemes died a quiet death a few years ago. Market-linked investments are now the norm. This means investors must periodically review their investments.

Ulips demand that the investor has a minimum understanding of financial products and is conversant with the working of the capital markets. If you are a passive investor who does not track his investments regularly, avoid Ulips. Also, for short-term and mediumterm financial goals, mutual funds are more suitable.

But if you are seeking an investment that combines tax planning, insurance, good returns and disciplined investing, call your insurance agent right now.