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During your shopping expeditions you must have come across a number of advertisements which say "Buy More For Less". You may have also heard "Buy Two Get One Free " and " Get 50% Extra ". What do they mean? These advertisements encourage you to splurge on products whether you require them or not. They tap human avarice or greed. The use of Financial Engineering and complex algorithms has led to such complex financial instruments that you cannot even comprehend. ULIP's are similar to two in one options which combine investment with mortality cover or death benefits. Not surprisingly these products are selling like hot cakes in the hands of insurance agents. You might have been mis sold such a policy or definitely you might know of someone who has been mis sold such a policy. You might have wondered why this happens to you. One of the main reasons is you and most of the people around you do not care to study these products. The insurance agents make use of your ignorance and greed to mis sell you these ULIP's. Every tool can be put to good use or bad. How you use these insurance tools is completely up to you. In order to invest in these ULIP's you definitely need to read up on them.
We have a famous saying "To Climb Steep Hills Requires Slow Pace At First ".
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What Is A Unit Linked Insurance Plan?
A unit linked insurance plan is a hybrid between insurance and a mutual fund. You might ask What Does A Hybrid Product Do? This basically combines the good properties of two different products to form a single product which is meant to have the good properties of both the products .Similarly ULIP's combines Insurance protection with the Investment component. This product is tailor made in which the consumer decides the premium to be paid as well as the sum assured. These ULIP Policies are more profitable than traditional insurance policies but carry a higher element of risk. The policy holder decides the proportion of the investment component vis-a–vis the insurance component. This transfers the risk element solely in the hands of the policy holder.
Why Would You Take Up A Unit Linked Insurance Plan?
· You would take up a ULIP Policy as it guarantees you a sum assured according to terms and conditions of your policy as long as premiums are payed and the policy is in force.
· ULIP's have a market linked component and this helps you to generate returns which beats the rate of inflation This is not guaranteed but since it has a market linked component chances are high that you would get more returns than most of the traditional financial instruments.
· You can take loans against these ULIP policies but the quantum of loan depends on the sum assured or the fund value of the policy and number of years for which the policy has been in force.
· If ULIP is Equity oriented you cannot take loans on more than 40% of the ULIP's Net Asset Value. In case of debt oriented ULIP's the limit increases to 50%.
· If you are paying a premium of less than 10% of the sum assured then it will be tax deductible Under Section 80 C of the Income Tax Act. Premium for ULIP's will be tax deductible provided the premium should not exceed 1 Lakh.
· Under Section 10(10d) the death benefits on ULIP's will be tax free in the hands of the nominee and any proceeds received from ULIP's on its maturity will be tax free in the hands of the receiver.
What Are The Charges And Fees In A Unit Linked Insurance Policy?
Premium Allocation Charges
Under this ULIP policy a part of the premium amount is set aside for charges before allocating the units and these charges consists of initial and renewable expenses. These charges were as high as 20% of the premium. Now it has been reduced to around 8% of the premiums payed because of reduction in commission charges
Mortality Charges
These are basically charged in order to cover the insurance costs which depends on factors like age of the policy holder insured, the sum assured, and the physical health of the insured. This is a compulsory expense which you have to pay irrespective of whether you have other health and life coverage policies. This results in a deduction in investable corpus.
Fund Management Fees
These charges are paid for managing the funds and charged as fund manager's fees. These charges are deducted before computing the net asset value. These charges are low at 1.35%.However these are levied on the accumulated fund value and not on the premium .As accumulated fund value increases due to the performance of the manager the amount deductible also increases.
Policy and Administrative Charges
This is a charge deducted from the premium in addition to premium allocation charges. This is a small sum in the range of INR 90-100.This is paid for about 5 year's .It increases by around 5% each year. This sum is a fixed deduction each year .Even though this sum may be small it has a higher effect on a policy in which premiums are low as it is a fixed cost.
Surrender Charges
These charges are for termination of the policy, mainly complete withdrawal of the units allocated or the partial withdrawal of the units allocated .These charges are high in the beginning and gradually come down to nil with the passing of time.
Fund Switching Charges and Service Tax
These are basically charged for switching of units from one fund to another fund. A certain number of switching of units is allowed on these policies free of charge each year. Based on the risk element of the policy service tax is deducted.
How Does A Unit Linked Life Insurance Policy Work
· The investor has to choose from a set of standard portfolios depending on his risk appetite. These may be aggressive such as those which have a high equity component, a conservative portfolio consisting of a mix of debt and equity and a very high debt component for those who are risk averse. The percentage of debt and equity can vary up to 100% depending on the investors risk perception or capabilities.
· The investor pays a premium and charges are deducted from this premium. Units of the chosen portfolios are taken up by the investor in a similar way to mutual fund units. This follows a pattern similar to a collective pool in a mutual fund .The money collected is invested in a predefined financial instrument which might be shares, debentures or money market instruments.
· A small part of the premium is set aside to provide the guaranteed health cover or the mortality cover and the life cover. On the death of the policy holder the sum assured is paid to the beneficiary.
· The income is gained by the unit holders in proportion to the units held by them. This is indicated by the Net Asset Value of the fund which rises or declines in lieu with the market. The product of the Net Asset Value of each unit and the number of units held gives the value of the policy.
· They have a compulsory lock in period of 5 years and withdrawal is not allowed for the first 3 years of the policy.
· They offer a guaranteed rate of return of 4.5% per annum on the premiums paid.
Types of Unit Linked Life Insurance Policies
Type 1 ULIP Policy
This policy basically charges a premium where a portion of the premium is set aside as an assured death benefit. The remaining portion is mainly used for the investible corpus?. What happens if you die during the course of this policy? Will you get both the components of the ULIP?.This policy on the death of the policyholder pays either the assured death benefit or the investible corpus whichever is higher. It retains the lesser amount among the two for itself. If you find that the investment portion is same as the assured death benefit you can raise the portion of the death benefits. However the increase in death benefits is subject to medical tests in order to gauge the health of the policyholder. You need to note that under such a policy charges are deducted from your premiums and if the investible component is lesser you get only the sum assured. This translates to a very expensive policy.
Type 2 ULIP Policy
This works in a similar manner to the Type I policy the main difference being the premiums are higher. The higher premiums are due to the fact that these policies pay both the assured death benefit as well as investible corpus on the death of the policy holder .Just like any ULIP Policy you have to bear the losses in case the fund underperforms and you can still choose your policy based on the premiums payed and the sum assured. If you surrender these plans early owing to higher costs of premiums your surrender value is almost nil.
Pension Plan ULIP Policy
Under this plan the policy holder pays a premium for the ULIP Policy. As per latest rules passed after September 1st 2010 these policies have to provide a compulsory health cover or a life cover. It has a five year lock in period. On death of the policy holder before he attains the retirement age he will get the assured death benefits. These policies allocate about 65% of the corpus towards an annuity plan. The remaining 35% of the amount is invested to give market linked rate of return. A guarantee rate of at least 4.5% needs to be provided as a return on investment. If you live to the retirement age a pension ULIP gives you the premiums paid and accrued interest back in full. The lump sum can be used to procure an annuity plan which aids you in your retirement years by making a regular set of monthly payments. These policies turn out to be very costly if they are abandoned before retirement. The charges for these insurance policies are deducted as explained above.
I would like to end this article with the famous phrase " If You Are Not Willing To Risk The Unusual You Have To Settle For The Ordinary ".
Happy Investing!!
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