When buying Ulip make good judgment

There has been a long discuss on unit-linked insurance plans (Ulips) recently, but consumers find that many questions continue to remain unanswered. Meanwhile, the sale of traditional products has increased extensively despite the fact that Ulips are far more transparent today.

So how do you know if an Ulip works for you, and if it does, which type is right to your needs? There are two broad categories of Ulips, which are defined by the death benefits they offer. The Type 1 Ulip provides benefits that are higher of the cover or the accumulated fund value.

The Type 2 Ulip offers death benefits that include both the cover and the accumulated fund value. It is important that you assessment these two products as both the death benefits and mortality charges are higher for the second category. Here are some factors that you should consider before buying an Ulip.

Don’t buy only to save tax: Under the current income-tax regulations, Ulips enjoy the following benefits:

Under Section 80C, the premium paid is eligible for deduction, provided the cover is at least 5 times the annual premium.

Under Section 10(10) (d), the maturity payout is tax-exempt.

However, according to the revised Direct Taxes Code, which will be implemented in April 2012, tax deduction will be available only in policies where the cover is 20 times the annual premium.

Tax advantages should not be the only reason for investing in Ulips, nor should the investment amount be decided on the basis of deduction available under Section 80C. It’s important to consider whether the cover and projected maturity value are sufficient to meet your specific need.

You should also make sure that you are able to pay the entire premium. Many Ulips offer flexibility in the amount of risk cover as a multiple of the premium that you can afford.

Compare returns: Instead of buying an Ulip, is it better to take a term insurance and put the balance in other investments? Ulips offer a mixture of benefits with a charge structure that optimises a bundled offer. After the capping of charges, the new Ulips are competitive compared with any combination of products, such as term insurance and a savings product.

Additionally, tax incentives at the time of investment and on maturity are an important thought.

Let us compare an investment in a Ulip with that in a combination of products, say, a mutual fund or PPF along with term insurance (see table). To simplify the comparison, Ulip and mutual fund returns are assumed at 10(%) per cent (minus the charges) and PPF at 8.5(%) per cent. It is important to note that in an Ulip, the full maturity value is payable only at the end of the policy term provided all premiums have been paid on time.

This value will, in most cases, include loyalty additions through the policy term and early withdrawals will reduce the fund value to the extent of these additions.

This is a simplified example using a particular Ulip and a specific term plan. For the Ulip, the illustrated fund value on maturity has been taken. Even though Ulip charges have been simplified, each plan offers different benefits and charge structures. Term plan premiums can also vary significantly. So, compare the benefits and costs before investing.

Don’t buy for the short term: The minimum term for an Ulip is 5 years now and many offer policy terms of up to 30 years. No withdrawal is permitted in the first 5 years. This is a good feature as early withdrawals can deplete investments intended for a particular need.

You should be prepared to invest for the full term to avail of full benefits. Many plans have loaded benefits that reward the investors for staying with the policy till maturity.

Most new Ulips have in-built features that provide for liquidity in case of unforeseen situation. These include loans of up to 40(%) per cent of fund value and partial withdrawals.

If you are unable to continue paying the premiums or require a full withdrawal, you can surrender the policy. If this is done after 5 years, no charges are deducted and the full fund value is paid. However, if a policy is ended before the completion of 5 years, surrender charges are deducted, subject to a maximum of Rs 6,000, and the net fund value transferred to a special account to be paid on completion of 5 years.

If you are not confident about your ability to pay the premium for at least 5 years, you should seek an alternate investment, not an Ulip. Remember to take a pure term insurance to cover your protection needs.

Assess your risk appetite: Most Ulips have a variety of fund options ranging from aggressive equity, diversified equity and balanced funds to bond or income funds and short-term funds. Choose the ones that suit your risk profile and appetite.

You can allocate a desired part of your investments in the fund(s) of your choice. Ulips offer the flexibility to switch between funds depending on your changing needs.

Investing in an Ulip is a long-term commitment and it’s essential to compare products. If it suits your specific financial goals, go ahead and buy one.

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Tags: Term Insurance, term plan, ULIP