Investment word of the day: Unit-linked insurance plans — how ULIP works, pros & cons and more

Investment word of the day: Imagine you have a sum of money and you are confused about whether to use it for investment or as a measure to protect finances from unforeseen circumstances. A unit-linked insurance plan (ULIP) is a financial product that offers the benefits of both.

What is ULIP?

A ULIP provides benefits of both life insurance and market-linked investments. Your payments to these companies when you buy a ULIP are called 'premiums' as they are more like insurance plans. A part of your premium is diverted for investment. ULIPs have a mandatory lock-in period of five years.

Why ULIP must be considered?

“One of the remarkable benefits of ULIPs is the ability to encourage financial responsibility. They come with a mandatory five-year lock-in period which motivates long-term savings and ensures deep commitment to wealth accumulation,” according to Siddharth Maurya, MD & Founder of Vibhavangal Anukulkara.

“Moreover, being able to switch funds depending on market activity gives the flexibility needed to maximise returns while minimising risks. This dynamic nature makes ULIPs a tactical option for systematically designing wealth,” he added.

ULIPs provide tax benefits as well. Premiums qualify for deductions under Section 80C, while maturity proceeds, subject to certain terms, enjoy tax waivers under Section 10(10D) of the Income Tax Act.

“ULIPs serve as a comprehensive financial instrument for long-term investment and protection due to a blend of disciplined investment, tax benefits, liquidity, and life insurance cover. Beyond enabling financial growth, the integral life insurance component supports dependents as well. Upon the death of the policyholder, the nominee is guaranteed protection through the fund value or sum assured, whichever is greater,” Anukulkara said.

Costs associated with ULIP

ULIP offers dual benefits of insurance and investment. However, it must be noted that there are several costs associated with it.

Premium allocation charges: An amount is deducted before the premium is utilised for insurance and investment purposes. This is known as premium allocation charges.

Mortality charges: On the basis of the insurer's health condition, age, and duration of the policy, a mortality fee is charged for the insurance part of ULIP.

Fund management charges: This fee is charged to maintain funds under ULIP. It is capped at 1.35 per cent per annum by the Insurance Regulatory and Development Authority of India.

Switching charges: Upon changing between the investment portion of the funds, switching charges are levied.

Surrender charges: On premature withdrawal of ULIP, surrender fees are levied based on the lock-in period.