What Makes ULIP A Bad Investment Choice?

We often have readers asking us, if Unit Linked Investment Plans (ULIP) are good. To begin with let's understand what an ULIP is.

ULIP: An insurance and investment

A Unit Linked Insurance Plan is a combination of investment and an insurance product. Let's take the subject of insurance in an ULIP plan and understand, what insurance they provide.

An ULIP provides 10 times of the premium paid as insurance. So, if you pay an annual premium of Rs 1 lakh, in case you were to die, the nominee would get Rs 10 lakhs.

In case an investor survives, then he or she gets the amount of premium paid, plus the returns generated.

Why we do not like the ULIP?

The problem with the ULIP is you neither get decent returns nor do you get decent insurance coverage. We have already spoken of the insurance part and now let's talk of returns. An investor has the option of choosing where your premium is invested in an ULIP. Your premium can be invested in equity mutual funds, debt mutual funds or a combination of both.

The problem here is that if you pay Rs 1 lakh premium, a portion of that goes for various charges like mortality charges, administrative charges, premium allocation charges etc. In the initial years, the various deductions means the entire Rs 1 lakh is not invested and a lot goes for charges. This results in lower returns for the investor. How much goes in charges is difficult to quantify, but, in the first year do not be surprised, if only Rs 90,000 to Rs 92,000 or thereabouts is invested.

The problem is that the insurance component too is very low. If you use a small amount of the premium paid as a plain vanilla term insurance plan, you could get an insurance coverage of Rs 40 to Rs 50 lakhs easily, depending on your age.

In short, it makes sense to divide the Rs 1 lakh premium paid into a separate investment plan and a separate insurance plan. From a ULIP, neither are you getting the best investment and neither you are getting the best insurance coverage. It is a little bit of both.

So, you can spend Rs 20,000 for a term insurance plan and the balance of Rs 80,000 in investment. This is just a ballpark figure, it really depends on your age and other factors. All we are saying is that a separate investment plan is desirable. Apart from this there is a lock-in for 5 years and many ULIPS do not allow you to withdraw even after 7 years.

ULIPs have many advantages too

One does get tax benefit under Sec80C of the Income Tax Act. However, with the Finance Minister planning to gradually do away with some of the tax exemptions, who knows whether this remains for long. The maturity benefits from the ULIPs are also exempted from tax.

All in all, choosing an ULIP could be a matter of individual preference. You might want to consider a plain vanilla investment and insurance plan in place of an ULIP.

About the author: Sunil Fernandes has spent 26 years covering business and finance in India and abroad. Sunil has worked with frontline daily newspapers including Hindustan Times, Deccan Herald and Gulf Times. He has also worked with investment magazines like Dalal Street Investment Journal and Oman Economic Review. His forte remains stocks, commodities, debt, mutual funds and tax planning. Sunil is currently Managing Editor for Goodreturns.in