Indian expats: Is investing in Unit-linked Insurance Plans (ULIP) a wise choice?
ULIPs provides a life insurance cover to the policy holder along with investment options
If you’ve been on the lookout for avenues to invest, only to be bombarded with the several options available in the market, one product gaining popularity is a Unit Linked Insurance Plan (ULIP).
ULIP is a product offered by insurance companies that, unlike a pure insurance policy, gives investors the benefits of both insurance and investment, when the policyholder pays an annual or monthly cash installment (premium).
With numerous options available in the market like mutual funds, insurance plans, and fixed deposits, selecting the best investment method has been considered cumbersome.
With ULIP as part of your investment portfolio, it offers a balance between providing insurance cover and boosting your returns, which is why it has proven to be a one-stop option for your family’s financial security and your long-term financial goals.
ULIP investment offerings are primarily concentrated in India where they were first launched. HDFC Life is a popular provider of ULIP investments. The firm’s plans offer varying provisions, terms and investment options. Other ULIP providers include Aegon Life, PNB MetLife, Kotak Life, ICICI, IndiaFirst, SBI Life, and IDBI Federal.
ULIP investment offerings are primarily concentrated in India where they were first launched. HDFC Life is a popular provider of ULIP investments. The firm’s plans offer varying provisions, terms and investment options.
We will now go through in detail on the advantages and disadvantages of investing in ULIPs.
Hassle-free, switchable
There are fund managers in the insurance companies who manage the investments and therefore the investor is spared the hassle of tracking the investments.
ULIPs also allow you to switch your portfolio between debt and equity based on your risk appetite. What this means is, if you are willing to take a high risk, you may invest in equity, while those with a moderate risk appetite may invest in balanced funds (a mix of stocks and bonds for example).
Similarly, you may invest in bonds, if you are a risk-averse individual.
With the ULIP allowing you to switch among these funds based on the market outlook or your knowledge of the market’s performance, it allows you to obtain a higher return on your invested amount.
Simply put, if you see the stock market rapidly declines on uncertainty following a global catastrophe (case in point – a quick-spreading virus), you may choose to switch to reliable assets such as bonds and currencies.
The benefits of offering investors the flexibility of switching is a huge factor contributing to the popularity of these investment instruments.
Life-cover, long-term growth
With the additional benefit of ULIP being a life insurance product, the premium paid goes towards a lump sum amount made available in case of an unfortunate event of death of the policyholder.
With the insurance one may be assured that the beneficiaries will be looked after even in his/her absence and the assured amount may be used to meet their financial obligations, such as daily expenses, repayment of a loan, or meeting their lifestyle needs, among others.
TAX BENEFITS APPLICABLE ON ULIP FUNDS
• Section 80C: The government of India has made some exceptions for taxes on payments for insurance. Section 80C of the Indian Income Tax Act, 1961 states that any payment made towards insurance is eligible for tax deductions of up to INR 150,000 a-year. The benefit of this Act can be enjoyed by NRIs as well. Moreover, senior citizens can avail deduction benefits up to INR 60,000.
• TDS (Tax Deductible at Source): ULIPs payouts are done annually, half-yearly or monthly which can be chosen by the policyholder. These payouts can include amounts that exceed INR 10,000, which is the limit for payouts. Such amounts are prone to TDS deductions (government tax cuts), which can be claimed later while filing returns.
• DTAA: Sometimes NRIs end up paying taxes of both the countries (India and the country that they are residing in), which can reduce their overall income. You can avoid paying double taxes, if the country you reside in has a Double Taxation Avoidance Agreement (DTAA) signed with India.
India has signed the DTAA with more than 80 countries, so before applying, you need to check if the country has a DTAA with India. (Indian citizens residing in the UAE don’t have to pay double taxes as a DTAA deal was signed between the two countries since 1992.)
Firstly, for NRIs, to perform any banking and transactions in India, they need to open an NRE or NRO savings or current account. There is a certain procedure which has to be followed to open these accounts, and using these accounts, you can exchange your foreign currency for usage. Similarly formalities when investing in Indian products, include submitting your Indian passport, a permanent account number (PAN), a legal document authorizing someone else to handle matters in your place (Power Of Attorney) and in most cases a government issued identity card (Aadhaar).
NRI investors, who invest in the Indian stock markets, are advised initially to invest in options that are low at risk, and one such plan is ULIPs. NRIs can and do invest in ULIPs. In fact, it is one of the most common products sold by the private Indian banks to NRIs, according to a number of financial experts.
NRIs adhere to different taxation policies for banking and transactions. While interest earned on an NRE account and FCNR (Foreign Currency Non-Resident Account) account is tax-free, interest on NRO account is taxable for an NRI. The interests earned from an NRO are taxed at around 30 per cent, which is quite high when compared to domestic tax rates.
TROUBLES WITH INVESTING IN ULIPs
Complex and expensive – The premiums (monthly payments) paid on availing insurance with ULIPs is much higher than the premiums paid for insurance policies that provides protection for a definite period of time (term plans).
Additionally, it is not explicitly declared as to how much of the premiums invested will go towards ensuring protection and how much of it works as an investment. It is best to ask and clear these details with an insurer, before the tenure of the investment has begun.
It is not explicitly declared as to how much of the premiums invested will go towards ensuring protection and how much of it works as an investment.
Stay invested for 5 years – With ULIPs, investors must agree to a lock-in period, which is typically 5 years. During this time, there is no partial withdrawals allowed from the fund.
Fluctuating market conditions – It is not possible for investment instruments to generate high returns all the time, especially if they are dependent on market conditions like ULIPs are.
As a result, sometimes, fluctuations in market conditions result in low returns with ULIPs. However, since these instruments have a lock-in period of 5 years, returns are generally balanced out in that time period before investors have access to them.
Switches are chargeable – While insurers could provide free switching between the ULIP-linked funds for a certain number of times, they could start charging beyond a certain number of times (depends on the insurer).
It is important to clarify the number of free switches allowed with the ULIP being opted for, while discussing ULIP pros and cons with investor agencies.
Closed architecture – While a ULIP typically offers 4 to 6 fund options, they are all from the same company. If you are unhappy with the performance of that company, you cannot switch to another company. Although mutual funds may be more flexible in this regard.
More of an investment product – These are predominantly ‘investment’ products, as the insurance part is nominal. So if you’re looking for insurance, you’re better off buying a term plan for adequate and relatively cheap insurance cover.
Higher costs during initial phase – ULIPs are more expensive in their initial phases of investment, and cost more because of the charges levied on the investor. We will discuss this in detail next.
HIDDEN CHARGES, A COMMON PITFALL FOR ULIP INVESTORS
Policyholders should look at cost structure carefully before investing in ULIPs as higher costs will reduce the value of your investments and in the end take a bite out of returns in the long run.
In 2010, the insurance regulator capped the exorbitant charges levied by the insurers. Currently, there are four kinds of charges in ULIP – ‘allocation’, ‘policy administration’, ‘mortality’ and ‘fund management’ charges, which we will go though in detail below.
Premium allocation charge:
These are the initial expenses incurred by the insurance company at the time of policy issuance. It includes fees such as cost of underwriting (taking on risk), medical expenses, agent's commission, etc.
After deducting these charges, the remaining amount is invested in the chosen fund. Say, your premium allocation charge is 20 per cent and your total premium is INR 50,000. Then INR 10,000 will be deducted by the insurer as premium allocation charge and INR 40,000 will be invested.
Mortality charges:
Mortality costs are higher for ULIPs as compared with life insurance policy that provides protection for a definite period of time (term plans).
These charges compensate the company in case the policyholder does not live till the policy period and if the insurer has to pay any death benefit. The mortality charge will depend on the age of the policyholder, occupation, location. Greater the age, greater would be mortality charges on the ULIPs.
Mortality costs are higher for ULIPs as compared with life insurance policy that provides protection for a definite period of time (term plans). They are deducted on a monthly basis. This charge will be deducted proportionately from each of the fund(s) you have chosen.
Fund management charge:
The fund management charge is as the name suggests deducted towards managing the fund. Though it differs from fund to fund, as per the regulatory limit, life insurance companies cannot charge fund management fees more than 1.35 per cent annually.
Usually, the debt-linked ULIPs will have a much lower fund management fee than their equity-oriented counterparts. What investors must bear in mind is that the fund management costs are levied on the accumulated amount, not just the premium paid.
Therefore, in real terms, the more accumulated, the actual amount deducted as fund management fee goes up. You are charged as soon as you inject funds into the ULIP.
Surrender charges or discontinuance charge:
After you stop making premium payments, typically after the first five years, your money will be locked in what is technically called a ‘Discontinuance Policy (DP) Fund’ after deducting the discontinuance charge (DC) in the policy.
The regulator (IRDA) has laid down guidelines on the maximum surrender charges that can be levied by life insurance companies, which is not over 0.5 per cent a year on the policy-holder’s ULIP value.
The regulator (IRDA) has laid down guidelines on the maximum surrender charges that can be levied by life insurance companies, which is not over 0.5 per cent a year on the policy-holder’s ULIP value.
If the annual premium of a policy is more than INR 25,000, the maximum DC can be INR 6,000, INR 5,000, INR 4,000 or INR 2,000 in the 1st, 2nd, 3rd, 4th year of the policy, respectively.
For any amount lesser than that, it will be INR 3,000, INR 2,000, INR 1,500 or INR 1,000 in the 1st, 2nd, 3rd, 4th policy year, respectively. In case the policy is discontinued from the 5th policy year, there is no surrender charge.
Switching Charges:
An investor is allowed a fixed number of free switches between different fund options every year. Subsequently to this, each switching would attract charges, which could go up to INR 100-500 per switch, subject to the insurer's charge structure agreed with the policyholder at the start.