Thursday, September 11, 2008

Why Avoid ULIP?

I will demystify the ULIP plan, which is widely used everywhere now-a-days!

To state it fast and simple, it is a plan with both Investment and Insurance with Tax benefit. Sounds cool? But it isn't really. Lets see how.

ULIP is Unit Linked Insurance Plan, which means they are going to invest in shares (similar to mutual fund) and also give insurance in the meantime as well. There are charges (hidden) everywhere. There are Fund Management charge, Mortality charge, Allocation charge etc., for a ULIP plan and this will be more in the first few years based on the plan.

Usually, based on the plan,
I year - 15% to 65%
II year - 3% to 15%
III year - 3% to 15%

There is not much charges from the third year in plans offered by few companies out there. So, where these high charges go? Do they really need this much for managing your fund?

1. There should be some amount for giving you insurance and this can't and shouldn't be invested. So, it constitutes fair percentage based on your age. As your age increases, the amount to insure you also increase naturally.

2. For managing your money. Proper allocation of funds in shares by analysts.

3. Fees for agent. Agent may be your friend/cousin. He will get a big share when you invest in ULIP under his guidance.

4. Other charges based on the fund you are choosing.


Does it provide ample insurance?
If you think it provides ample insurance for you, then the amount going to investment will be less and vice versa. Finally, I have seen many thinking of ULIP as a investment opportunity. Even the agents, who has to clarify these things, are making things more complicated by projecting huge returns at the end of 3 years. I can assure you that this will not be the case. There are stories in the net showing how they even lost their money in spite of market moving up at the same time.

Take this case.
John invests Rs. 1 Lakh in ULIP plan every year for 3 years. He takes an insurance for 1 Lakh.

We will see how much will get invested in share market as his share.

Commissions from 15000 to 65000. For 1 Lakh, Mortality charges will be Rs. 150/-
S0, totally Rs.35000 to Rs.85000 gets invested and he gets shares worth it under him.
If you see the average of commissions in ULIP plans, it comes to around 50% in the first year. Thus, we will take Rs.49850/- as his share to market in the first year.

I year -> Rs. 49850/-

Commissions from 3000 to 15000 in the second year. On an average, it is around 5% in the second year. Mortality charges would have increased in the second year. So, let us take it as Rs.175/-

II year -> 94825/-

Commission from 3000 to 15000 in the third year. on an average, it is around 4% in the third year. Mortality charges would have increased and let us take it as Rs.200/-

III year -> 95800/-

Most of them are investing in ULIP for tax saving purpose and want money after 3 years. This is because the minimum lock-in period in case of tax-saving instruments is 3 years.

If we consider a secure investment like PPF, it gives 8% interest in a secure manner. Considering Share market also gives the same interest (for the sake of discussion), John may end up losing Rs.43644/- after 3 years without considering any profit on his principal.

When will I get at least the amount I put in?
Here, John has invested 3 Lakhs (A lakh every year). To get back 3 Lakhs at the end of 3 years, Stock market should have performed really well to give 40% return every year. Sometimes, the stock market may give 40% in a year. But it won't be consistent.
At the end of 3 years, even your principal is not returned to you in full!!

If I consider 8% secure return on my principal amount, I need to get a return of 55% in the stock market every year, which is almost impossible.

I can hear you saying, I get insurance coverage during this period. For getting insurance coverage, please use a Term Insurance. To see the advantages of having Term insurance, you can see this post.
Even if you consider this insurance taken as term insurance, you need to either get 35% return to find no return on your capital or 50% to get 8% return on your capital.

The best one to choose among the lot for tax saving is
PPF - For secure returns without insurance.
ELSS - For high returns with risk without insurance. (This is a mutual fund)
Term insurance - For insurance

Don't combine both insurance and investment. They are different and are meant to be different.

3 comments:

  1. I will say ULIPS are not that bad. If you find rite product mix with good managers . This gives a life security and investment returns in long term . Incase you need realtime answers do rite me n sanjeev.anand@aegonreligare.com

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  2. @vikas thanks

    @sanjeev
    I second that still even though the ULIP charges have been reduced!
    First, one good news, ULIP can be considered as a medium investment instrument from a bad investment instrument.

    Even now, the term insurance + Mutual fund beat the ULIP by a good margin in the long term. And ULIP is a long-term instrument :-)

    Term Insurance - life security and
    Mutual fund - investment returns according to your risk profile.

    You can also select the Mutual fund with the same/similar manager for proper management of fund.

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