Why you should not invest in Unit Linked Insurance Plan (ULIP)?

Still investing in ULIP for a tax benefit? In the union budget 2018 there is a levy of 10% long-term capital gain tax on earnings from equity. Insurance companies are taking full advantage of this new tax rule and pitching ULIPS to people for tax saving. But check this points before you actually take the decision of buying ULIPS.

What is ULIP?

ULIP is the market-linked insurance plan which invests in equity or debt oriented schemes. It also provides an endowment in a form of a guaranteed sum assured. In a layman’s language, it is a mix of insurance and investment plan. It is popular among Indians as we Indians are obsessed to pay charges in returns of some benefits.

Why are ULIPs so popular?

  • For only tax saving
  • People don’t understand insurance product
  • Some near and dear one has suggested buying
  • Something in return for the premium paid
  • Tax-free returns

In the recent years ULIPs are becoming popular due to the above points, however, it is necessary to check the other side of the coin as well.

Check below points before taking investment decision for ULIP.

Check the charges

ULIPs comes with the set of different charges. It is important to know these charges. In the initial years of investment, these charges are higher. Usually, in the first 5 years, charges are higher. So you will not see high returns in the initial years. These charges are Premium allocation charges, policy administration charges, management fees, Mortality charges etc. Below table shows the typical charges for ULIPs. You can see that in the initial 5 years, these charges are higher.

ULIP charges

Go only for a long-term horizon

In ULIP you have to pay the premium for as long as you hold them. If you stop paying a premium, your life cover lapses. So if there is anything unwanted happened only the remaining fund value will be paid to your nominee and not the sum assured. There will be various other charges which will be deducted from the residual amount until the policy expires. ULIPs have a lock-in period of five years. This doesn’t mean that you should withdraw your money after completion of five years. It will take 10 to 12 years to get the best out of ULIPs.

Don’t buy ULIPs only for tax saving purpose

Yes, of course, tax planning is clearly a major agenda, you should also look for other objectives while purchasing ULIPs. These objectives are long-term wealth creation, retirement planning, child’s education/marriage. The decision taken only for the tax saving purpose will often result in the purchasing a wrong and unsuitable product.

Choose investment option as per your risk profile

Remember, ULIP is the market linked investment instrument and never guarantee you fix returns. Market’s movement will affect the return it generates. Check the past performance of various funds before making a decision. Compare various plans and investment option before concluding your purchase.

Use the switching facility when appropriate

Switching facility from equity to debt and vice versa is the unique feature of ULIPs. You should use it as per the market condition to gain the maximum out of it. You can switch your option without incurring any tax liability.

Have an adequate life insurance cover

Remember, ULIP is not a full proof insurance plan. ULIPs will typically give you a sum assured of 10 times of the premium amount. So if you are paying Rs 50000 premium per your, you will get 5 lakhs of sum assured. This sum assured is not enough to protect your family in case of anything wrong happens to you. As a thumb rule, you should have a life cover of 10 times of your annual income. So if you are earning 12 lakhs per annum, you must have a sum assured of Rs. 1.2 crore. For this, there is a term plan available. Go for the pure term plan as per your income.

What should I choose?

As a thumb rule, never mix insurance and investment. If you have financial dependents, the first thing you should do is to buy an adequate term insurance plan. Then put the rest of the residual savings into equity mutual funds. Here is the list of the best mutual funds to invest.

If you don’t want to take the risk then go for PPF. It will still give you a better return than ULIPs.

Here is a comparison chart.

We have taken 3 investment options, 1) Endowment Plan 2) ULIP 3) Term plan + mutual funds. The table below tells us the kind of returns it will generate for a period of 10 years.

It is clearly visible that term plan with mutual funds will give you best returns in the long-term. It also gives you an adequate life cover.

Comparative-returns

Now let’s go deeper to check is the mutual fund + term insurance is the right pick or not?

There are a plethora of the articles on this comparison. Different people have different opinions. In the below comparison let’s find out which one is better.

ULIPS:

  • ULIP is basically an insurance + investment plan
  • ULIP has a higher cost
  • Life cover linked
  • All costs are not declared
  • Triple tax benefit structure is applicable.
  • No tax liability on withdrawal
  • ULIP has a lock-in period
  • An investor can switch from one option to another
  • Offline paperwork is required

Mutual Funds + Term Plan:

  • The mutual fund is purely an investment plan
  • The mutual fund has comparatively lower cost
  • No life cover in MF. It is covered by term plan
  • Transparent product. All costs are declared.
  • Tax benefit applicable only on ELSS schemes and term insurance
  • Long term/ short term capital gain taxes are applicable.
  • Mutual funds are liquid
  • In the Mutual fund, you have to exit one plan to enter another
  • A Complete online process

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