A reader says, “Hello, sir- I have made the folly of investing in ULIPs. I have read enough articles from people like you, who I trust to know it was a mistake. What I want to understand is what do I do next? Should I wait till the five-year lock-in and then withdraw my capital? Or should I stop paying more premiums ( I’m in year 3)? I see many articles on why ULIPS are bad but very few on what to do if you have already invested. Please help!”
About the author: Ajay Pruthi is a fee-only SEBI registered investment advisor. He can be contacted via his website plnr.in.
This guide offers a step-by-step process for exiting a ULIP (before 5 years) or conducting a thorough assessment to determine if exiting the ULIP is genuinely necessary. This guide does not promote or advocate the purchase of a new ULIP.
Step 1: Check if it is ULIP or a Traditional policy.
This seems to be a very silly point but it is a very important one. I’ve encountered numerous clients who struggle to differentiate between a traditional life insurance policy and a ULIP.
Once you’ve successfully identified it as a ULIP, Congratulations! 🎉
The reason to celebrate is that with ULIPs, you’re not bound for an extended period like 10, 15, or 20 years as compared to traditional policies. The lock-in period is only 5 years, and even if you discontinue paying premiums, you’ll receive your existing fund value along with an interest rate of approximately 4% from the life insurance company.
Step 2: Premium Allocation Charges
Premium allocation charges refer to the percentage the life insurance company deducts from your premium before investing the remaining amount.
Let’s assume a life insurance company imposes a 5% premium allocation charge for the initial 5 years. If you pay an annual premium of Rs. 1 Lakh, an amount of Rs. 5,000 will be allocated towards these charges, and the remaining Rs. 95,000 will be invested in your chosen fund option. These charges are normally used to pay commissions to agents for their efforts.
Typically, these charges range from 4% to 5% during the policy’s first 4 or 5 years.
However, there are ULIPs available in the market now with zero premium allocation charges. The policy functions more like equity or debt mutual funds in such cases, depending on your fund selection.
Whether the premium allocation charges are 4%-5% or zero, it’s not necessarily a reason to surrender the policy at this stage. Before making a decision, consider the following key points.
Step 3: Policy administration charges
Policy administration charges cover the expenses incurred in managing the administrative aspects of a ULIP. These charges are deducted monthly by cancelling a certain number of units from your investment. These charges normally persist throughout the entire term of the policy.
For example, If a life insurance company imposes a policy administration charge of Rs. 100 per month, and you pay an annual premium of Rs. 30,000. This would still account for 4% of your premium. However, if the annual premium is Rs. 1 Lakh, then the policy administration charges would be 1% of the premium. Some companies cap it to 500 per month or 1% of the premium, whichever is less.
Thus, the percentage of policy administration charges varies depending on the premium amount you pay.
Some ULIPs do away with premium allocation charges but increase the policy administration charges instead. So, it is always better to combine these charges.
When you combine premium allocation and policy administration charges, and if they are in a high range (even 4%-5% is considered high), it might be prudent to consider surrendering the policy.
But weighing the impact of these charges on your returns is essential to make an informed decision regarding your ULIP.
Step 4: Returns and Benchmark
Not every ULIP is a bad investment, just as not every equity mutual fund is a good investment.
Drawing from my experience with approximately 1500 clients, I have seen certain ULIPs performing at par with good mutual funds. But even if the fund performance is at par, due to the impact of premium allocation charges and policy administration charges, the net return to the investor will be less.
When people claim that ULIPs are poor investments and advocate for equity mutual funds instead, there is no guarantee that you would have chosen the right mutual funds after listening to their advice.
Furthermore, there is no assurance that you would have remained invested in those mutual funds over time. Human behaviour often lacks the discipline necessary for consistent investment. In some cases, the lock-in period of ULIPs can help promote better returns.
The most crucial point to consider is your expectations regarding returns from the ULIP. For instance, if you expected a 10% return and your policy delivers an 11% return, it may still leave you dissatisfied because certain mutual funds have provided returns in the range of 15%. However, this alone should not be a reason to surrender the policy. There will always be investment instruments that outperform your current holdings, but constantly changing investments based on that would be unwise.
So, it would be wise to take a decision considering points 2, 3, and 4 together. If all parameters indicate a negative outlook, surrendering the policy might be a better course of action.
However, if the returns align with your expectations and goals, even if the charges are high, it is advisable to continue with the policy.
Why? If you surrender the policy, the fund value will be transferred to the discontinuance fund, where you will receive a minimum interest of 4% on your fund value, as you cannot withdraw money until the lock-in period of 5 years is over.
Tax Implications When Surrendering ULIP Policies
If you’ve decided to surrender your ULIP policy, seeking advice from your Chartered Accountant (CA) or investment adviser is essential to understand the tax implications involved.
Different tax rules apply to policies purchased after February 2021 and those purchased before that date.
Additionally, the tax rules may vary based on the sum assured of the policy and whether it is a pension policy.
Here are a few cautions and charges to consider:
- Suppose you have a pre-existing medical condition, so you cannot purchase a term insurance policy (assuming you don’t have one already). In that case, it’s advisable not to surrender the ULIP.
- Surrender charges will apply to your policy, depending on the number and amount of premiums paid. These charges are subject to a maximum of Rs. 6,000 if you surrender after one year and reduce after the first year.
- Fund management charges for ULIPs are generally comparable to those of equity mutual funds (excluding index funds).
Remember, there’s no one-size-fits-all solution when it comes to surrendering ULIP.
Just because some people may view it as a bad investment doesn’t mean it’s unsuitable for you. If the existing ULIP aligns with your financial goals, it might be your best investment option.
If you still have any questions, please feel free to ask.
Till then, Happy Investing!
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