While the low charges of new Ulips make them attractive, the main advantage is the seamless and tax-efficient transfer from debt to equity, and vice versa. This switching may be for varied reasons, including rebalancing the portfolio or even timing the markets by savvy investors.
"Though retail investors may not have the bandwidth to switch on the basis of market views, people who are aware can make use of this facility very effectively," says Alam. It is important to note that Ulip is not just about equities. Smart investors can also move within debt, shifting to long duration funds when interest rates are expected to go down and moving to short-term funds when rates are on the rise. If mutual fund investors do this, they will have to pay tax on the short-term and long-term capital gains made on the fund. Since Ulips are insurance plans, the gains and maturity proceeds are tax-free under Section 10(10d).
However, the sum assured must be at least 10 times the annual premium for this tax benefit. This year's budget has changed tax rules for debt funds. The minimum holding period has been increased from one year to three years. Debt fund investors will have to pay higher tax if they rebalance by shifting out of debt within three years of investing. However, there will be no tax in case of Ulips. Investors should note that insurance companies allow only a limited number of free switches. While some Ulips allow unlimited free switches, others permit only 4-12 free switches in a year. There is a Rs 100-250 charge for every switch beyond the free limit. Like banks, insurance companies also charge you less if you do the transaction online. For example, HDFC Click2invest charges Rs 250 per additional switch if done offline and only Rs 25 if the same is executed online.
Decoding the charges
The charge structure of Ulips is not as straightforward as that of mutual funds. There is a premium allocation charge, a policy administration charge and a fund management charge. There is also the mortality charge for the life cover offered by the plan. The 2010 Irda guidelines say that the combined charge cannot be more than 2.25% a year in the first 10 years. They have also capped the fund management fee at 1.35% per annum, though many Ulips are charging less than that on their short-term debt schemes.
The mortality charge differs across Ulips. Some plans offer either the sum assured or the fund value on death. These are Type I Ulips and their mortality charges go down as the fund value goes up. The Type II Ulips offer both, the fund value as well as the sum assured. Obviously, the mortality charges are higher when it comes to such plans.
Though Ulips offer a cover to policyholders, the benefit may be a drag for those who are interested purely in investment. The low-cost Ulips are, therefore, Type I plans that will pay either the fund value or the sum assured. Here's how it will work. Suppose a person buys a Ulip with a Rs 1 lakh premium for 20 years. The plan will give him a cover of Rs 10 lakh (10 times the annual premium), but the insurance company will charge mortality premium for only Rs 9 lakh since the total risk for the company is Rs 9 lakh. With every annual payment of the premium, the risk of the company will come down, reducing the mortality charge. When the fund value of the Ulip exceeds the sum assured, the plan will stop deducting mortality charges and the entire premium will go into investment.
Another way to reduce the impact of mortality charges is to buy the policy in the name of your spouse or child. Income from investments made in the name of a spouse or a child are subject to clubbing provisions, but since the maturity proceeds from Ulips are tax-free, you don't have to worry about that. You can also go for single premium Ulips, with an insurance cover of only 1.25 times the premium. However, the maturity proceeds of such a plan will not be covered under Section 10 (10D) and will be taxable in your hand.
Before you buy a Ulip take this short test to know if you should buy such a plan
You already have adequate life cover
You typically need an insurance cover of 5-6 times your annual income. This entire insurance need may not come from a Ulip, so buy a term cover before you consider buying a Ulip.
You understand that Ulips are market-linked products
Like mutual funds, Ulip Insurance India also invest in the markets. Be prepared for the market risk that the investment will be exposed to. Not only equity funds but even debt funds can decline in value.
You know that exiting in 5-6 years will not yield desired results
Ulips were mis-sold as investments you can exit within three years. The lock-in period has been extended to 5 years but to get the best out of the Ulip, you need to hold it for at least 12-15 years.
You know how to use the switching facility
The switching facility of a Ulip is a key feature that differentiates it from a mutual fund. You can shift money from debt to equity, and vice versa, depending on your reading of the market.
You can afford to pay the premium for the entire term
As mentioned earlier, it is important to continue investing in a Ulip through the term of the plan. Buy a policy that you can continue for the full term without impinging on other financial goals.
[source: http://timesofindia.indiatimes.com/business/india-business/Why-you-should-invest-in-Ulips-now/articleshow/44458163.cms]
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