What is Unit Linked Insurance Plan and How Does it Work?

 

A Unit Linked Insurance Plan (ULIP) is a financial product that provides both life cover and market-linked investment opportunity. It helps ensure the insured individual's family members future is secured and also grows wealth by taking advantage of different types of funds. A portion of the premium secures the life cover, while the remaining amount goes towards investment. Let's find out what is unit linked insurance plan, how ULIPs work, their benefits and how they differ from other types of investment.

 

What is a unit-linked insurance plan?

Unit-linked insurance plans (ULIPs) offer life cover along with investments in market-linked investment avenues. ULIPs allocate a portion of your premium towards securing life cover for your loved ones, while the remaining amount is invested in various funds based on your risk appetite and financial objectives.

 

ULIPs offer the following:
 

• Dual advantage of protection and investment: Part of the premium amount secures life cover and the remaining is invested. 

• Fund switching facility: Switch across funds based on market conditions. Tax* benefits: Up to ₹1.5 lakh tax deduction per annum under Section 80C on premiums paid, and tax-free maturity proceeds under Section 10 (10D). 

• Wealth creation: Potential wealth generation for long-term goals like retirement, children's education, and buying a home.
   

Now that you know what is ULIP definition, and what is a ULIP plan, lets see how ULIP works next.

 

How does a ULIP work?

Life insurance works on the basis of premium payments. The premiums you pay are used to offer financial protection to your family in case of an eventuality. In a ULIP, the same premium is divided into two parts. One part of the premium goes towards the life insurance plan, while the remaining portion is invested in the financial market. This is how a ULIP typically works:
 

This is how a ULIP works:
 

• The premium is paid in lump sum or on a monthly, quarterly, semi-annual, or annual basis.

• The corpus invested by a policyholder is divided into units, which have a certain value.

• The value of a unit is called the Net Asset Value, assigned to you based on your investment.

• This plan offers the maturity benefit at the end of the plan tenure.

• The capital gains during the policy term are calculated by the increase in the NAV of the units.
   

Scenario 1: Death during policy term

The nominee receives the higher of the following if the policyholder dies during the policy tenure:
 

• Sum assured [Life cover amount]

• Fund value (value of investment accumulated)
   

This will ensure that your family gets significant financial protection, irrespective of market performance, and has their future financial needs covered.
 

Scenario 2: Survival to maturity

If the policyholder survives the entire policy term, they receive the complete fund value accumulated through market-linked investments. The maturity amount shall comprise:
 

• Initial investments made through regular premiums

• Capital appreciation from market growth

• Any top-up premiums invested during the policy term

• Compounded returns over the investment period

The maturity proceeds are exempt under Section 10(10D), subject to conditions, and therefore, ULIPs remain an efficient wealth creation tool.
 

Now that you know what is ULIP and how it works, lets see how they are structured further in the article.

 

How is a ULIP plan structured?

ULIPs follow a structured approach to wealth creation:
 

• Premium payment: You can choose flexible payment options – monthly, quarterly, semi-annual, annual, or lump sum payments – according to your cash flow convenience.

• Premium allocation: After deducting the applicable charges, the premium is allocated to life insurance coverage and an investment in your chosen funds.

• Unit allocation: The investment sum is transformed into units at the current Net Asset Value (NAV), which is announced every day by the insurer.

• Fund management: By analysing the market trends and changing the allocation of the assets according to the fund's objectives, professional fund managers actively manage your investment portfolio.

• NAV calculation: The daily calculation of the Net Asset Value per unit involves taking the total fund value and dividing it by the number of units that are still in circulation, thus giving a real-time reflection of market performance.

• Maturity benefit: At the end of the policy term, you get the total fund value, which is calculated as the product of the number of units you have and the prevailing NAV on the maturity date.

   

What is the benefit of Unit-linked insurance plans?

ULIP investment offers a range of benefits that include: 
 

• Allows planning for future goals

  ULIP insurance offers the combined advantage of savings, investment and life cover. By investing in a ULIP, you can plan for long-term goals such as retirement planning, wealth creation, education or wedding expenses. Not just this, ULIP allows you to financially secure your loved ones in case of your absence.

• Helps diversification of investment portfolio

  ULIP investment allows you to choose between the fund options according to your needs and risk-taking capacity. You can invest in equity if you have a high-risk appetite. But if you are risk-averse, you can choose more fixed-income assets. The diversification of assets allows you to take advantage of market opportunities to enhance your investment corpus.

• Offers flexibility of investment

  One of the benefits of the ULIP insurance plan is the option to switch between funds. You can switch between equity and debt according to market volatility or risk appetite. Thus, a ULIP offers a high degree of flexibility in investment type and amount.

• Offers tax benefits

  Unit-linked plans allow tax* benefits under the Income Tax Act, 1961, wherein the premiums you pay and returns earned by you are exempted from tax under Section 80C and Sec 10(10D) of the said act.

• Encourages disciplined savings 

  Paying your premiums regularly often helps you develop a habit of disciplined savings. This systematic approach helps you stay committed to your financial goals while building a substantial corpus over time.

• Transparency in investments 

  ULIPs offer total transparency through regular fund performance updates, declaration of NAVs, and charge breakdowns. You may also track your investment progress through online portals and mobile apps to keep yourself updated on the status of your policy at every given point in time.

Features of Unit-linked insurance plan

The ULIP features that make it a versatile financial product are:
 

• Fund switching facility

  ULIP plans allow you to switch between equity, debt, and balanced funds within the same policy without any tax* implications. Most insurers offer a certain number of free switches annually (typically 10-12), after which nominal charges may apply.

• Top-up premium facility

  The top-up facility allows you to invest additional amounts beyond your regular premium whenever you have surplus funds. These top-ups are directly allocated to your chosen funds, helping you accelerate your journey of wealth accumulation.

• Partial withdrawal option

  After the mandatory 5-year lock-in period, ULIP policies allow for partial withdrawals from your accrued fund value. Most plans allow a certain number of free withdrawals, subject to conditions, that provide liquidity for emergencies while letting the rest of your investment continue to grow.

• Choice of premium payment terms

  ULIP wealth investment plan offers flexible premium payment options, including regular pay, limited pay, or single premium. You can also choose payment frequency, monthly, quarterly, half-yearly, or annually, based on your cash flow convenience.

• Life cover options

  Most ULIPs provide two types of life cover: Type 1 offers sum assured or fund value (whichever is higher), while Type 2 offers sum assured plus fund value. You can choose based on your protection needs and premium affordability.

   

Things to consider before investment in ULIP

Before buying a ULIP plan, you must consider the following aspects to make an informed decision:
 

• Long-term financial goals and needs

• Your risk appetite

• The features and benefits of ULIP

• Fund options available

• Policy charges and terms

• Scope of flexibility to switch between funds

• Premium payment options

• Insurance coverage

• Claim settlement ratio of the insurance company

   

Unit linked insurance plans vs. other investment options available under section 80C

Understanding how ULIPs compare with other Section 80C investment options helps you make informed decisions:
 

Investment Option	Lock-in Period	Risk Level	Tax Benefits	Insurance Cover	Liquidity
ULIP	5 years	Market-linked	Premium: Sec 80C; Maturity: Sec 10(10D)	Yes	Partial withdrawals after 5 years
ELSS	3 years	High	Premium: Sec 80C; Gains taxable	No	After 3 years
PPF	15 years	Low (Govt-backed)	Premium & maturity: Tax-free*	No	Limited withdrawals after 7 years
NSC	5 years	Low	Premium: Section 80C; Interest taxable	No	No liquidity
EPF	Till retirement	Low	Premium & maturity: Tax-free	No	Limited withdrawals
Tax-saving FD	5 years	Very Low	Premium: Sec 80C; Interest taxable	No	No liquidity

What is a ULIP fund?

A ULIP fund denotes the investment component of your Unit Linked Insurance Plan, wherein a portion of your premium is invested in market-linked financial instruments. These funds are professionally managed portfolios that put the funds into different kinds of assets, which may include shares of equity companies, government bonds, corporate bonds, money market instruments, and other securities as per the fund's investment goal.

 

Top tips for managing ULIP funds

Here are some tips you can follow to manage your ULIP investments.

1.​‍​‌‍​‍‌​‍​‌‍​‍‌ Understand your unit linked insurance plan: First and foremost, understand your unit-linked insurance plan and how does it combine insurance cover with market-linked investments. Analyse the breakdown of premiums, how the computation of NAV is done, and on what aspects your returns depend to make proper choices.
 

2. Set your financial goals: Clearly define your financial goals – be it retirement, education of a child, or creation of wealth. Accordingly, invest your ULIP in line with these goals, keeping in mind your time horizon and risk tolerance.
 

3. Monitor performance of the funds: Once every few months, the performance of your ULIP should be monitored and tracked. For a quantitative review of performance, compare it with similar other plans. If it is underperforming, then you can rebalance your portfolio accordingly.
 

4. Review and rebalance your portfolio: Market fluctuations can impact your portfolio. You should review your investment annually or when your returns are not what you expect.
 

5. Be alert to market trends: Know what is happening in the market with respect to movements, interest rates, and policy changes. Being proactive can help you allocate your funds according to the ongoing trends.
 

6. Do not switch funds often: Avoid switching funds too frequently; do not react to short-term market changes. Discipline and staying focused on your long-term goals can assist in the long run.
 

7. If necessary, take advice from a financial expert: In case you are unable to make any decision regarding performance or allocation of the fund, then seek advice from a financial ​‍​‌‍​‍‌​‍​‌‍​‍‌advisor.

 

Fund options under ULIPs

ULIPs offer diverse fund options catering to different risk appetites and financial objectives, allowing you to customise your investment strategy:
 

• Equity funds
  Primarily focused on company shares, offering higher growth potential with higher market risk.

• Debt funds
  Focused on fixed-income securities like bonds and debentures, ensuring stability and steady returns.

• Balanced funds
  Maintain a mix of equity and debt to achieve a balance between risk and reward.

• Liquid funds
  Hold short-term, low-risk instruments that allow quick access to funds when needed.

   

Fund comparison table

Fund Type	Risk Level	Investment Horizon	Ideal Investor Profile
Equity Funds	High	Long-term (10+ years)	Aggressive, long-term wealth seekers
Debt Funds	Low	Short to medium-term	Conservative, capital preservation-focused
Balanced Funds	Moderate	Medium-term (7-10 years)	Moderate, balanced growth seekers
Liquid Funds	Very Low	Very short-term	Ultra-conservative, liquidity needs

Note: Return potentials are indicative based on historical trends and not guaranteed. Actual returns depend on market performance, fund management, and economic conditions.

 

ULIPs: Myths vs Reality

There are some misconceptions about ULIPs. Let's explore the reality.

 

1: ULIPs are too expensive and come with a lot of charges

Reality: It’s easy to assume ULIPs are costly, but when you look at what they actually offer—life insurance cover, market-linked growth, and tax advantages—the overall value becomes quite clear. For someone thinking long term, the benefits often outweigh the charges.

 

2: ULIPs are extremely risky and not meant for most people

Reality: The type of fund a ULIP invests in decides the risk associated with it. While debt funds usually have a relatively lower risk, growth funds often come with a greater risk. But a fund with a mix of the two may balance the overall risks. You also get the choice to switch funds as your financial situation or the market conditions.

 

3. ULIPs don’t generate competitive returns

Reality: Since ULIPs invest in market-linked funds, their return potential is comparable to other investment products. The key difference is the added life insurance cover and the tax-free* maturity benefit under Section 10(10D), which may improve your overall gains compared with taxable options.

 

4. The 5-year lock-in period is too limiting

Reality: The lock-in exists to encourage disciplined investing, something most people struggle with. In fact, five years is a relatively short commitment compared with instruments like the PPF. Once the lock-in ends, you can make partial withdrawals while continuing to stay invested.

 

5. ULIPs are complicated and difficult to follow

Reality: It's not difficult to understand how ULIPs work. A certain part of the premium paid goes towards securing the life cover, and the remaining amount is invested in market-linked funds. In addition, apart from the policy document that contains all the required details, nowadays, insurers are also providing regular updates and online platforms to manage your plan conveniently.

 

Conclusion

ULIPs combine life insurance cover with market-linked investments, making them suitable for long-term goals such as retirement, education, or wealth building. They offer benefits like fund-switching flexibility, possible tax* advantages, and partial withdrawals after the five-year lock-in. However, it’s important to understand the plan’s charges and market risks before investing. You can choose the Tata AIA life insurance policy and secure your financial future. Choose a ULIP that fits your financial goals, risk appetite, and time horizon, and consider insurers with transparent processes and a reliable and easy claim settlement process for a better experience.