ULIPs - Advantages and Disadvantages

Unit Linked Insurance Plans (ULIPs) are plans th []at combine life insurance with investment options linked to the market. They allow you to invest in different types of funds while still having some protection for yourself or your loved ones. ULIPs come with advantages such as the potential for growth, flexibility to switch between funds, and long-term coverage. However, market-linked risks, possible charges that reduce returns may need regular monitoring. Understanding both sides can help you decide if a ULIP suits your goals and comfort with risk. In ULIPs, the investment risk in investment portfolio is borne by the policyholder.

What is a unit linked insurance plan (ULIP)?

A Unit Linked Insurance Plan (ULIP) is a life insurance product that combines protection with investment. It allows you to invest in market-linked¹ funds while also providing life cover. A ULIP can help you build wealth systematically like other investment options, while ensuring financial security for your family through the sum assured. Investing in a ULIP is a great strategy, especially if you are looking to create a corpus to meet your mid-term and long-term goals.
 

However, before making a decision about which ULIP plan is better, here are some features, pros, and cons of this tool that you must be aware of.
 

What are the various features of a ULIP?

The following are the features of the ULIP plan:
 

• Life insurance coverage

  A ULIP offers life insurance coverage, which helps ensure that your loved ones get covered along with investing in the chosen funds.

• Market-linked returns

  The returns of a ULIP are market linked¹, meaning the returns are based on how the market performs, allowing your investments the potential to grow as the funds perform well.

• Partial withdrawals

  You can withdraw part of your investment after the lock-in period, which can help address short-term expenses without liquidating the entire investment.

• Switching option

  ULIPs allow you to switch your investments between equity, debt, or balanced funds.

• Tax benefits

  Premiums paid toward a ULIP are eligible for tax^* deductions, and the maturity proceeds is tax-free under specific circumstances.

• Lock-in period

  The lock-in period of five years in a ULIP promotes regular investing and ensures that the fund is invested for sufficient period to grow.

• Loyalty additions

  Some ULIPs offer loyalty additions, where extra units are added after a specific investment period, enhancing the total value of your fund.

• Fund options

  Multiple fund options allow you to select investments that align with your risk tolerance and financial objectives.

What are the Advantages of ULIPs

Here are some advantages of a ULIP:
 

• Offers more returns

  The funds you invest in a ULIP are invested in the stock market. This enhances the potential for higher returns. During favourable market conditions, these investments can generate significant growth.

• Creating wealth for future generations

  A ULIP offers multiple benefits within a single policy. It provides a sum assured allowing you to accumulate wealth for your dependants, while also building wealth for your own future. This advantage ensures both protection and long-term financial growth.
  

• Can be used as an emergency fund

  One of the useful features of a ULIP is that it allows partial withdrawals after the mandatory lock-in period of five years. Although ULIPs are primarily considered mid or long-term investments, they can be highly effective in the short term in case of an urgent financial need.
  

• Provides you with tax benefits

  Under the ULIP tax^* benefits, premiums paid are eligible for a deduction of up to ₹1.5 Lakh under Section 80C of the Income Tax of 1961. The death benefit paid to the nominee on the demise of the policyholder is completely tax-free.
  

• Offers flexibility

  A ULIP allows you to switch between funds multiple times to ensure that your money reaches its optimal growth.
  
  

What are the Disadvantages of ULIPs

Here are some disadvantages of a ULIP:
 

• Subject to market risk

  Your funds are invested in the stock market and are therefore subject to market volatility. Your returns depend on market performance and may result in either a gain or a significant loss.
  

• Costlier than other insurance plans

  As compared to other insurance plans, such as term insurance, whole life insurance, etc.,  which are pure protection plans, a ULIP can be more expensive as it includes protection with wealth creation. So, this may not suit individuals with a limited budget.
  

• Fixed lock-in period

  The fixed lock-in period for a ULIP is 5 years. During this period, you cannot assess or withdraw your money.
   

• High costs and charges

  ULIPs include multiple fees such as premium allocation, policy administration, and fund management charges, especially higher in the early years, which can reduce your overall returns.
   

• Market risk and no guaranteed returns

  Since ULIPs are linked to market performance, returns are not guaranteed and can fluctuate based on market volatility, leading to potential losses.
   

• Five-year lock-in period

  ULIPs come with a mandatory 5-year lock-in period during which withdrawals are not allowed, limiting liquidity for short-term needs.
   

• Lower returns compared to mutual funds

  Due to higher charges and their dual structure of insurance plus investment, ULIPs typically offer lower returns than standalone mutual fund investments.
   

• Lower life cover

  A significant portion of your premium goes toward investment, resulting in lower life insurance coverage compared to pure protection plans like term insurance.
   

Are ULIPs a good investment?

ULIPs are investment options that combine life insurance with market-linked¹ growth, which makes them different from traditional plans. Compared to traditional plans, ULIPs provide life cover along with potential returns that may be higher due to equity exposure. ULIPs also include a lock-in period of five years, encouraging disciplined investing and long-term financial planning. Additionally, tax benefits under Section 80C and exemptions on maturity proceeds under Section 10(10D) further enhance their suitability for long-term financial goals.

However, ULIP returns are linked to market performance and may fluctuate over time. ULIPs may suit investors seeking long-term growth while securing life cover. However, understanding fund allocation, risk level, and policy terms is important before investing.
 

How is ULIP different from FD (fixed deposit)?

A fixed deposit provides fixed interest income for a chosen tenure. It is a low-risk option but does not provide life insurance. On the other hand, a ULIP combines insurance and investment. You receive life cover while also investing in market-linked¹ funds. Unlike FDs, ULIPs offer the flexibility to switch between different fund options, such as equity and debt. ULIPs also offer tax deductions on premiums under Section 80C and tax-free maturity proceeds under Section 10(10D). Besides this, you don’t pay GST on ULIP premiums for individual life insurance policies.

FDs only provide tax exemption on the invested amount, while the interest is taxable. The returns from FDs remain fixed and predictable, whereas ULIP payouts vary based on market performance. FDs may suit individuals looking for assured income and stability, while ULIPs provide an option that combines long-term investment growth with life insurance protection.
 

What is the death claim payable in case of ULIP?

In a ULIP, the death benefit is the amount paid to the nominee if the policyholder passes away during the policy term. The nominee will receive either the sum assured or the fund value, whichever is higher. Even if the fund underperforms and its value is lower than the sum assured, the insurer will still pay the full sum assured to the nominee.
 

When is the right time to invest in ULIP?

You should consider the following factors before planning to invest in a ULIP:
 

• Optimal timing:

  The right time to start ULIP investment is when you have a steady income and can commit to long-term premiums. Starting early may also help you benefit from the ‘Power of Compounding’.

• Age and life stage:

  At a younger age, you may prefer equity-oriented funds for potential growth. As you approach retirement, shifting towards debt-oriented funds may provide stability.

• Impact of market conditions:

  Although market fluctuations affect ULIP performance, it’s better to focus on long-term goals rather than short-term movements. Even in a down trending market, continuing with ULIP may support disciplined investing.

• Align with your financial goals:

  ULIP may be suitable when your financial goals align with the policy tenure. Whether it is for education, retirement planning, or asset building, aligning goals with the ULIP lock-in period is important.

Final words

ULIPs combine life insurance protection and investment opportunities, offering a dual benefit within a single plan. It provides flexibility through fund switching, partial withdrawals, and different fund options. The lock-in period also encourages disciplined long-term investing. At the same time, ULIPs involve costs and market-related risks that must be carefully assessed. Understanding ULIP advantages and disadvantages and aligning it with your financial objectives can help you decide whether it suits your long-term strategy.