FINANCIAL PLANNING: Ulips with low charges can beat mutual funds

Unit-linked insurance plans (Ulips) are market-linked insurance products, investing in equities and fixed income markets. They are different from traditional insurance policies. One key difference is that while conventional policies calculate the maturity proceeds by factoring in the sum assured and the bonuses of the plan, Ulips get redeemed at the market value of the investments at maturity. The sum assured comes into play only if the insurer dies during the life of the active policy period.

So how are they different from mutual funds (MF)? There are four factors: 

Insurance cover: Regular premium Ulips generally come with a life insurance cover of 10 times the premium paid. If the premium paid annually is Rs 1 lakh, the cover will be Rs 10 lakh. Ulips also come with a single premium option but the sum assured is 1.25 times the one-time premium paid.

Minimum premium paying terms: Investment in MF does not have any minimum tenure whereas regular premium Ulips come with a minimum payment period of five years. The policyholder has to compulsorily pay premium for five years or else the amount invested goes into discontinued fund and will be paid only after the completion of a minimum period of five years with a return of approximately 3.5% after factoring in the charges. 

Taxation: MF and Ulips both have debt and equity-based investment options. Switching from a debt MF to an equity one attracts either short term or long-term capital gains taxation whereas the switches between debt and equity schemes of Ulips are not taxed. The maturity proceeds under any policy that has an insurance cover of less than seven times are taxable. 

Further, the entire proceeds from Ulips are tax-free after the minimum premium paying term of five years. Returns from MFs attract capital gains tax.

Charges: MFs have only one charge, which is capped by the Securities and Exchange Board of India as per the fund size. Mostly, it is below 2% (for better performing funds) whereas Ulips have four charges:

Premium allocation charge: This is an upfront charge that gets deducted before the premium paid/money invested. For example, if the annual premium is Rs 1 lakh and the premium allocation charge is 5%, then the insurance company will deduct 5% of the annual premium (Rs 5,000) and invest Rs 95,000 on the policyholder's behalf.

Policy administration charges: These are towards the administrative expenses incurred towards maintenance of the policy. These are mainly charged on a monthly basis. 

Fund management charges – As per the Insurance Regulatory and Development Authority regulation, an insurance company can charge a maximum of 1.35% on the total investment value. The charges are not on the premium paid but on the actual fund value. 

Mortality charges: These are incurred for providing the cover to the policyholder and are based on the age, health and gender of the policyholder. This is based on the concept of “value-at-risk”. As subsequent premiums get paid, the risk of the insurance company reduces, thereby reducing the mortality charges as the policy term progresses. 

These charges distinguish a good Ulip from a bad one. 

To make themselves relevant in the competitive landscape of fund management business, the insurance companies have launched what they call as “the new-age Ulips”. 

The following charge structure makes a Ulip a good one.

1. Zero premium allocation charge

2. Zero policy administration charge

3. Fund management charges – 1.35%

4. Mortality charges 

Now if we actually evaluate the above cost over the five years for a healthy male of 30–40 years, then the Ulip cost is quite comparable to that of a mutual fund. 

The good Ulip charges compare strongly with that of an MF coupled with few very interesting and added benefits such as the inter-scheme switches are not taxable, the entire maturity proceeds are tax-free, the premium invested will qualify for tax rebate under section 80C and an added advantage of the insurance cover. 

Most investors invest via systematic investment plans in equity-linked savings schemes (tax saving mutual fund). The challenge of doing SIP in ELSS is that each instalment gets locked in for a period of three years, making the withdrawal of the proceeds very cumbersome and is subject to long-term capital gains tax.

In Ulip, one pays an annual premium. After paying five premiums and completing five years, the entire proceeds can be withdrawn at once, tax-free. This makes Ulips a worthy competitor to ELSS as well.

Ulips are not bad provided you pick the right one. Read the offer document, invest wisely.

The writer is founder and CEO, Fincart