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How Does A ULIP Plan Work?

Financial planning

Financial planning is needed to achieve your dreams and also to survive any unexpected crisis that may occur in life. Choosing the right investment and insurance options are both crucial decisions that impact your financial standing. If you are looking for investment options alongside insurance, there is an instrument that offers both. It is a Unit Linked Insurance Plan (ULIP). With a ULIP, you get life insurance and investment in a single plan. Before buying a ULIP, it is important to understand what a ULIP is and how it works:

What is ULIP?

ULIP is a modern life insurance product, where, along with a life cover, you also come across investment opportunities. The premiums that you pay for the plan are applied towards meeting two goals. One-half of the premium is used for providing life insurance to the policyholder, while the other half is used towards the investment goals. The purpose of the life insurance here is that in case of the sudden demise of the policyholder, the nominee receives a sum assured as per the policy. When the policyholder has survived the plan, he receives a maturity amount that comprises investment and the returns earned on it.

How does a ULIP work?

ULIP mainly comprises two components: life insurance and investment. Here is how it functions:

The life insurance component

The insurance part of ULIP is simple to understand. It works like any other life insurance plan. When you buy a ULIP, your life is covered for a specific tenure. If within that tenure, the policyholder loses their life, the nominee that they have mentioned in their ULIP will receive the death benefit. The death benefit is the sum assured or NAV (Net Asset Value) of the funds invested, whichever is higher. This leaves the policyholder relieved with the knowledge that in their absence, their loved ones have a financial backup to rely on.

Also, since ULIP is life insurance at its core, it offers tax benefits on multiple levels. The premiums that you pay are exempt from taxes under Section 80C of the Income Tax Act. The death benefit that the policyholder receives is also exempt from taxes, as per Section 10 (10D) of the Income Tax Act.

The investment component

A part of your premium is paid towards investments of your choice. For the investment aspect of the plan, there are several components involved. They are:

Fund options

When you buy a ULIP, there are several types of funds to choose from based on your risk appetite. If you invest in equity funds, your money is allocated to equity-based products. These funds are usually rewarded with high returns for the high risks involved. People who want an investment with a higher NAV usually invest in equity funds. If an individual does not want to invest in any risky funds, they would allocate their money to debt funds. The returns are lower than that of equity funds, but so is the risk. If an individual wants to take moderate risks, there are balanced funds. In such funds, the money is partly invested in equity and partly in debt.

Fund switching

One of the most remarkable features of a ULIP is that one can switch amongst these investments whenever one wants. By switching between different types of funds, investors make the most of the market fluctuations. Based on the risk appetite, investors can switch from debt to equity and vice versa. This enables investors to meet their ULIP goals in the long haul with ease. For the long haul, compounding enables investors to multiply their returns. It allows them to earn returns on investments along with the returns earned in the previous years. Also, the recurring payments inculcate the habit of savings amongst investors.

Access to funds

ULIPs have a lock-in period of 5 years. After that, ULIPs allow free partial withdrawals. The free partial withdrawals are quite handy to individuals when they urgently need funds. They can access them with ease without having to dissolve their investments or pay additional charges.

ULIPs offer insurance and investment. There are several charges that are associated with it to manage these two components. The common charges levied are policy administration, mortality fees, fund management charges, premium redirection, and premium allocation charges. Earlier, when ULIP was launched, these hefty charges led to a decrease in sales. In recent years, these charges have come down drastically, leading to more and more people investing in ULIPs.