Understanding the risks and charges involved is a basic rule of investing in a ULIPs. This helps you take an informed, accurate and effective decision.
A Unit Linked Insurance Plan (ULIP) is unique in its composition. It provides with a life cover as well as an opportunity to invest and gain money. Linkage to the capital market ensures ULIPs have a faster growth trajectory. But, with better growth comes higher risk. Thus, before finalising on investing in ULIPs, pay attention to a few basic parameters.
Risk
A risk is the possibility of your portfolio increasing or decreasing in value due to external sources. Any investment tool having links to the capital market brings risk with it. Thus, you need to understand how much risk you can take for your portfolio. ULIPs allow for complete aggression by allocating 100% of your funds to the equity market. There is provision for someone to go for a more conservative portfolio as well. That is, with 100% funds dedicated to the debt market.
There is risk of liquidity as well. These is because plans have a lock-in period of 5 years. Pre-mature withdrawal of the policy would result in charges eating into your returns. That is not a desirable outcome.
Charges
Know the underlying cost of your policy to understand your policy better. Insurance agents or companies skip most of these.
Allocation charges
While issuing the policy to the customer, insurance companies bear the distribution fees and underwriting costs. To recover these expenses, insurance companies deduct allocation charges. The customer are unknown to these costs as they eat up a certain percentage of your policy premium. The entirety of the remaining amount is available to invest in funds of your choice.
The IRDAI interrupted to reduce these high costs. They put a cap on the charges insurance companies can set on their customers. Even then, the fees are high for the first few years.
Administrative charges
During the policy period, the insurance company is liable for its administrative maintenance. These ensure to cover up the expenses of policy initiation, documentations and more. Most policies trust customers for monthly administrative charges.
Deductions can be either as a flat fee all through the insurance term or as increments. In case of increments, the percentage is pre-defined.
Management charges
Fund management fees allow for the smooth running and management of funds. The deductions settle in even before the Net Asset Value (NAV) calculation takes place. The important thing here is that these charges are on the total sum accumulated, not only individual premiums. This results in these growing over time.
But, fund management fees are much lower for debt-based funds as compared to their equity fund counterparts. The intervention by IRDAI also results in a cap of 1.35% as management charges.
Mortality charges
Mortality charges provide you insurance. A certain percentage of your policy premium, goes in as insurance. Based on factors such as age, lifestyle and gender, the insurance companies have life expectancy for individuals. If anything happens to the insured during this period, mortality fees pay off for insurance companies. This component also depends on the life cover you opt for during policy creation.
Discontinuation charges
Handing over units before end of the policy term means discontinuation or surrender. If this happens within the lock-in period, you end up paying charges. The IRDAI limits these deductions to about 50 basis points of the policy premium on a yearly basis.
The charges are higher for ULIPs in the first few years. The lack of liquidity doesn’t help them too. But, for a time frame of 5 years and more, ULIPs make for a compelling product. If you are looking for a disciplined and strong product for the long term, ULIPs are worth the visit.