A checklist on charges involved in ULIPS

A Unit Linked Investment Plan (ULIP) is an instrument which combines insurance and investment. A part of the investments are used to provide life cover and the remaining amount is used to make investments in a unit fund. With ULIPs, you can top-up, switch between funds, increase or decrease the protection level during the term of the policy, choose to continue your cover, exercise options to surrender, and avail of the deductions under Section 80C of the Income Tax Act.

These days, making an investment is easier than ever, and there is a surfeit of instruments to choose from in the market. But before we discuss the costs associated with the Unit Linked Investment Plan, let’s quickly recap what a ULIP is.

A Unit Linked Investment Plan (ULIP) is an  instrument which combines insurance and investment. A part of the investments are used to provide life cover and the remaining amount is used to make investments in a unit fund. With ULIPs, you can top-up, switch between funds, increase or decrease the protection level during the term of the policy, choose to continue your cover, exercise options to surrender, and avail of the deductions under Section 80C of the Income Tax Act.

Initially, ULIPs have higher associated costs from charges towards the policy. In fact, you pay between 15-40% for the first year and then around 5% for the next two years.

Going by the way you pay your premiums, ULIPs can be:

• Regular premium paying, where you pay a fixed amount every year (monthly, quarterly, half-yearly or annually) for at least the first three years of the policy
• SP ULIP, where you have to pay a lump sum just once

If you choose the regular premium option, in the first three years, the cost you have to bear is about 60 per cent of the premium you pay. Alternatively, if you buy SP ULIPs for three consecutive years, it would cost you around 10 per cent of the premium you pay every year.

For SP ULIPs, first there is the premium allocation charge, which can be compared to the entry load for an ELSS. This ranges from 2 to 4.5 per cent for amounts below Rs 1 lakh, and goes down for higher amounts.

Then there is fund management cost, which is similar to the Mutual Fund recurring expense ratio.

Include the mortality cost, which is based on the difference between the sum assured and the value of the fund.

Some SP ULIPs also carry a ‘surrender charge’ for exiting the plan in the fourth and fifth years as well.

The ‘policy administration charge’ is deducted from the fund value either as a percentage, a fixed sum every month, often based on the sum assured.

Since most of the charges are recovered at the start of the tenure (usually in the first three years when your money is locked in) ULIPs make sense only if investments are made for a long tenure (15 or 20 years) thus defraying initial costs.

For instance, an agent who sells you a ULIP may get 25% of your first year’s premium, 10% in the second year, 7.5% in the third and fourth year and 5% thereafter. If your annual premium is Rs 10,000 and the agent’s commission in the first year is 25%, it means only Rs 7,500 of your money is invested in the first year. So even if the NAV of the fund rises, say 20%, that year, your portfolio would be worth only Rs 9,000-much lower than the Rs 10,000 you paid. This shows how ULIPs work out expensive for investors.

Before buying a ULIP policy, review all the charges deductible under the policy, what payments there are on premature surrender, its features and benefits, and limitations and exclusions, and the consequences if the policy lapses.