A unit-linked insurance plan (ULIP) is a multi-faceted financial product that provides insurance coverage and investment exposure. It requires policyholders to make premium payments, a part of which goes into life insurance while the remaining portion is invested in equities, debt funds or a combination of both. To properly understand the meaning of ULIP, you need to know how such a plan works.
How does ULIP work?
Even though ULIP schemes are offered as an insurance product, such plans also work as an investment opportunity that helps build wealth and meet your long-term financial goals. Much like any insurance plan, you would also have to pay premiums for the ULIP you have invested in. A portion of these premiums would be invested in your chosen funds.
If your risk appetite is high, you may invest in equity finds. Conversely, if you want to avoid taking much risk with your money, you could always invest in debt funds. That being said, you will always have the option to invest in a combination of debt and equity funds to enjoy good returns with moderate risk. You need to carefully think about your life goals, budget, and the risk level you can afford before zeroing in on the type of funds to invest your money in.
Insurance companies allow you to switch between funds from time to time based on the terms and conditions specified in your policy documents. You may switch the funds based on your changing investment goals and the performance of the funds in the market.
For instance, if a specific fund is consistently underperforming, it can be a good idea to switch to one with a track record of delivering better performance. You can switch from one asset class to another based on your evolving life goals. For example, as you invest in a ULIP scheme in your 20s, you are likely to have fewer responsibilities and, therefore, can go for higher risks and put your money in equity funds. But as you get older, have kids and move closer to retirement, you may switch to debt funds that have a low risk.
Fund options under ULIPs
Equity: This is a high-risk investment option where your premium is majorly invested in the equity markets. Such funds also provide relatively high returns.
Fixed Income Funds: This is a medium-risk investment where a major part of your premium shall be invested in debt instruments like fixed-income bonds and government securities. Such funds provide low to medium returns on investment.
Liquid Funds: These funds come with low risks and also provide low returns. Under these policies, a major part of the premium goes into liquid investment options like money market instruments and cash equivalent securities.
Features of ULIP
- Investment Allocation: One of the top features of ULIP schemes is that they allow you to invest in funds based on your risk appetite and life goals, no matter whether you want to stay conservative with debt funds or be aggressive with equity funds.
- Fund Switching Option: If your investment requirements change or you foresee a change in market conditions, you can easily switch your fund type and modify your investments.
- Tax-Saving Instrument: The premium paid for ULIPs is eligible for deductions up to INR 1.5 lakhs under Section 80C of the Income Tax Act, 1961. This is applicable when specified conditions under Section 10(10D) are met. Otherwise, the amount of deduction is capped at 10% capital sum assured for ULIPs issued on or after 1st April 2012 and 20% capital sum assured for ULIPs issued before 1st April 2012. The death benefit due to the policyholder’s untimely demise (during policy term) is also tax-free u/s 10(10D) of the Income Tax Act, 1961.
- Partial Withdrawal: In case of a financial emergency, you can withdraw money from your ULIP funds, provided it is after the initial five-year lock-in period. The cap on withdrawal amount and number of withdrawals would depend on your specific plan.
- Top-ups: As you get married or have children, your financial goals and requirements are likely to evolve and you may want to increase your investment accordingly. ULIP schemes allow you to invest an extra amount over and above your regular investment in the plan so that you can get better returns at the end of the policy tenure.
Now that you understand how ULIP plans work along with their features, you can make an informed decision towards this investment and insurance coverage option. It is better to stay invested in such a plan for the long term so that the effect of market volatility is balanced out. A higher portion of your premiums will go into investment funds with time, thereby helping you to build a substantial corpus via your chosen ULIP scheme.
