Understanding the Lock-in Period in ULIPs
Unit-linked insurance plans, or ULIPs, come with a lock-in period of 5 years during which partial withdrawals are not permitted. Moreover, during the lock-in period, you cannot exit the policy and terminate the coverage. Though you can surrender the policy, you can receive the surrender value only once the lock-in period has ended. Plus, surrendering within the lock-in period also incurs surrender charges.
How ULIPs work
When you invest in a ULIP, a part of your premium goes towards life insurance coverage while the other part is invested in funds of your choice., by the insurance company. The plan provides life cover for which mortality charge will be deducted.
ULIPs also provide policyholders with the option to switch their portfolio between equity , debt and hybrid funds depending on their risk appetite. This flexibility allows the policyholders to choose a plan that aligns with their goals. .
In 2010, the Insurance Regulatory and Development Authority of India (IRDAI) brought in a few changes, and one of them pertaining to ULIPs was to increase the lock-in period from 3 years to 5 years. That is, no liquidity is offered during the 5-year lock-in period. Considering the fact that life insurance is a long-term product, policyholders might not enjoy the complete benefits of ULIPs unless they hold it for the entire duration of the policy.
Key Characteristics of ULIPs
- Transparent & Flexible: ULIPs are popular due to their transparency and flexibility, as they allow policyholders to choose the market linked fund option according to their risk appetite.
- Financial Planning: ULIPs are suitable for those who are looking for life insurance coverage and investment options to get their financial goals done.
- Long-term investment: ULIPs are long-term financial products, that provide life insurance cover and also help you create a long-term corpus for your goals.
- Switching: ULIPs provide policyholders with the option to switch their portfolio between equity ,debt, hybrid funds , subject to policy t&c.
- Tax Benefits: People invest in ULIP schemes because of its tax benefits.
Why the ULIP Lock-in Period Matters?
The lock-in period in ULIP is important as it motivates you to stay invested in the plan for a specified minimum period. As you stay invested, your fund value has the potential to grow with market movements and enjoy attractive returns. Moreover, the lock-in period can also help you maintain financial discipline..
Another benefit of the lock-in period is the tax benefits. If you surrender the ULIP within the lock-in period of 5 years, the tax benefits allowed under Section 80C (old tax regime) on the premiums paid would be reversed. The deduction allowed in previous years would be treated as income in the year of surrender and attract tax.
Types of ULIPs
Based on the types of funds, ULIPs can be divided into different types.
A. Funds ULIPs invest in
a. Equity funds: The premium paid is invested in equity markets. These are subjected to higher risks and offer relatively higher returns
b. Debt funds: The premium paid is invested in debt instruments. These are subjected to lower risks, but also offer comparatively lower returns
c. Hybrid funds – The premiums paid are invested in a mix of debt and equity instruments. The risk is moderate and so is the return potential.
B. Few objectives of ULIP investments could be:
a. Child’s education: Long-term investment made for a child’s education, or savings for unforeseen circumstances
b. Wealth creation: Investments made for wealth creation, and for achieving future financial goals
c. Retirement: Investments made to save for retirement, whilst still being employed
C. Death benefit
a. Type I ULIP: This type pays the higher of the sum assured or the fund value in case of death of policy holder to the nominee
b. Type II ULIP: This type pays the total of sum assured value and the fund value in case of death of policy holder to the nominee.
ULIP Tax Benefits
Under Section 80C of the Income Tax Act, 1961, the premium paid towards ULIP plan is allowed as a deduction, with the maximum amount allowed being Rs. 1.5 lakhs. The amount of deduction will be restricted up to 10% of actual capital sum assured if policy is issued on or after 31 March 2012 other wise 20% of actual capital sum assured.
ULIPs also offer tax-free maturity. As per Section 10 (10D) of the Income Tax Act, 1961, the annual premium should be less than or equal to 10% of actual capital sum assured if policy is issued on or after 1 April 2012 otherwise 20% of actual capital sum assured. These tax benefits make ULIP an attractive investment option, and with features such as fund switching and partial withdrawal, ULIPs have become a popular investment option for policyholders.
Why exiting ULIPs immediately post lock-in period is not a good idea
There are policyholders who buy ULIPs not as long-term investments, but as medium-term investment options, and exit ULIPs once the lock-in period ends. The objective here should be achieving your Life Goals in the long run. However, if that’s not the case, then you do not get the complete benefits from ULIP returns. Moreover, ULIP charges are applicable in the initial 5-year lock-in period.
These charges remain and recovery of the same along with returns requires time. Thus, the real benefits of ULIP plans can be derived after the lock in period ends.
Different types of fees and ULIP charges
1. Premium Allocation Charge (PAC): The Premium Allocation Charge is the fixed percentage that is deducted from the premium paid. PAC is front-loaded; that is, it is deducted from the premium when the premium is paid and then the remaining amount is allocated to selected funds.
2. Mortality Charges: Mortality charge is deducted for the insurance coverage provided under the policy/plan. Mortality charges vary from one individual to the other, and depend on various factors such as age and sum assured, and are deducted every month through cancellation of units.
3. Fund Management Charge (FMC): Fund Management Charge (FMC) is charged by the insurance company for managing various funds in ULIP scheme. The net asset value (NAV) is adjusted according to the charge,. This charge is deducted on a daily basis.
4. Policy administration charge: The policy administration charge is levied for the administration of the policy. The charge is either flat throughout the policy period, or could vary at a predetermined rate, and is deducted every month by cancellation of units from the fund value.
5. Partial withdrawal charge: Policyholders can opt to partially withdraw the funds, and while some plans offer unlimited withdrawals, others only offer limited withdrawals. These can either be free up to a certain limit, or are charged based on the transactions depending up on the product terms and conditions.
6. Fund switching charge: Fund switching charges are applicable when the funds or investments are moved between the various fund options. This is free up to a certain limit, or could incur a charge per switch depending up on the product terms and conditions.
7. Surrender charge: ULIPs have a lock in period of 5 years. Surrender charge is applicable only if you surrender your policy before the lock in period i.e. 5 years.
Exiting during a dip in the market can prove to be costly
ULIPs are market linked products and allow you to invest in equities—helping in wealth creation over the long term, and thereby enabling policyholders to achieve their long term life goals. Equities do come with intermittent volatility and correction, but has been among the top performing asset classes over the longer term, as indicated by historical data. Therefore, policyholders should not get overtly influenced by short term market volatility/corrections and discontinue their ULIP investments. Policyholders who are risk-averse can also consider partially switching to relatively less risky (or less volatile) fund options like bond / liquid fund, in the event of market volatility/correction. ULIPs are tax efficient and allow an policyholder to switch to various fund options (multiple times) without any charges (subject to policy terms and conditions) and capital gains tax implication, thereby allowing them to manage their asset allocation efficiently.
Overall, ULIP plans are a long term insurance-cum-investment product, and policyholders should not get deterred by short term market volatility/correction, and continue to invest using a systematic approach, thereby enabling them to create wealth (through the power of compounding) and achieve their long term investment goals.
Key Takeaways
ULIPs are life insurance plans that offer the dual benefits of life insurance coverage and market-linked returns.
ULIPs come with a lock-in period of 5 years, during which you cannot make partial.
Some of the key characteristics of ULIPs include transparency and flexibility, a long-term life insurance plan, tax benefits, a switching facility, etc.
The lock-in period in ULIP is important as it instils financial discipline, gives your fund value the potential to grow, and also helps you retain the tax benefits.
There are different types of ULIPs based on the market linked funds that they invest in, the objective of the plan, and the death benefit offered.
ULIPs offer tax benefits on the premiums paid as well as the policy benefits received.
There are different charges associated with ULIPs, like premium allocation charge, mortality charge, fund management charge, etc.
Exiting the ULIP after the lock-in period or in a market dip can prove to be a bad idea.
Conclusion
ULIPs are long-term financial products, and offer policyholders the dual benefit of life insurance with market linked investment. It is important to remember that to reap the benefits of the ULIP plan , the policyholders have to hold on until the policy matures. If the ULIP is purely equity-oriented, during the market fluctuations, it is important to hold on until the market bounces back, instead of exiting, hence it is better to plan your investments in ULIP products with a longer time horizon in mind to get your Life Goals Done.
Frequently Asked Questions
1. What is the lock-in period in a ULIP?
The lock-in period of ULIPs is fixed at 5 years. It is constant across all ULIPs.
2. What is the minimum lock-in period for ULIPs?
The minimum lock-in period for ULIPs is 5 years.
3. Can the ULIP lock-in period be waived in any special circumstances?
The ULIP lock-in period is usually not waived. However, if the life assured dies during the lock-in period, the death benefit is paid and the policy is terminated.
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