I will try and present an unbiased analysis of my ULIP from HDFC in order to discuss the positive and negative aspects of modern ULIPs. Most plans have a premium payment term of 10 to 15 years. The premium ranges from 50k to just over 2 lakhs as 2.5 lakhs is the maximum annual premium allowed for it to be tax free. My premium is a bit over 2 lakhs with a payment period of 10 years and a life insurance cover of 50 lakhs along with 50 lakhs of dismemberment and another 50 lakhs of disability coverage. The duration of the policy is 25 years. Some people would think that they got a better deal as their premium is lower or their payment period is smaller but this is like any investment: more you invest, more your corpus will be at the end.
Key Factors:
Negative Factors
Premium allocation charges:
These are collected typically for the first 4 years and are as follows:
12% for 1st year
6% for the 2nd year
4% for the 3rd year
3% for the 4th year
None from the 5th year onwards
NOTE: these charges are refunded 2X (double the amount paid) after 10 years. The charges collected in the 1st year are refunded via addition to the fund in the 11th year and the charges collected in the second year are refunded in the 11th year and so on. So we can sort of assume that we are allocating a portion of our investment in a fixed deposit that would double it in 10 years with a tax equivalent yield of 11% for this portion. However, there is some lost opportunity cost here.
Mortality charges:
These are the most insidious and perhaps the most harmful aspect of a ULIP. These charges vary by age and are collected daily by selling off your NAV units. There is a specific formula approved by IRDAI which is used to Calculate these charges. The older you are, the higher the charge and the higher the sum assured, the higher the charge as well. As a rough example, for a 30 year old, with a 50 lakh sum assured, this charge would be 0.8305 per 1000 of sum assured. This would translate to Rs 4152 annually. For a person at age 40, the charges would be 1.4280 per 1000, which would be 7140 per year. As you get older, these charges shoot up dramatically. At 50, you would pay 18853 per year, at 60, Rs 47438 and at 70 years old, you would pay a horrendous 1.02 lakhs per year!
See below as well.
Silver lining:
Firstly, these charges are imposed on the amount at risk for the insurer. The policy pays the sum insured or your corpus balance, whichever is higher (sum at risk minus fund value). When your corpus is zero, the insurer is bearing the risk for the full 50 lakhs and these charges would be calculated on full 50 lakhs sum insured. When your corpus has grown to 10 lakhs, the sum at risk is now 40 lakhs and the charges would be claculated on 40 lakhs value. When your corpus reaches 20 lakhs, the charges are based upon the remaining 30 lakhs value and if and when your corpus reaches 50 lakhs, the charges become zero. So the hope is that your corpus grows quickly to 20 to 30 lakhs in 10 years in order to reduce these charges as you grow older. The illustration at 8% growth (maximum permitted by IRDAI) shows that corpus at 25 lakhs at 10 years and 50 lakhs at around 18 years. However, the funds have grown historically at 26% and one can assume that one wouldn’t have to pay mortality charges after about 15 years unless there is a very long downturn the stock market.
Refunded at 2X. Even better feature is that these mortality charges are refunded back at 2X the amount paid starting from the 10th year. This is done by adding units monthly just as they were deducted. So, once again, we can assume that we are dedicating a portion of our investment to a fixed deposit that would double it in 10 years tax free.
Policy administration charge:
This is capped at 6k per year with no charges for the first 5 years.
Fund management charge:
This is 1.35% per year which is similar to most non direct mutual funds.
NOTE: These charges are fully refunded (1X) at the end of the policy term. So there would be a fairly large addition of 10 to 30 lakhs at the end to the corpus depending upon its total value.
Lock in period:
There is a minimum 5 year lock in period. You can surrender you policy earlier with a fee of 3k for the first year which falls to 1.5k in the 3rd year. When you surrender it before 5 years, the corpus amount is transferred to a fixed deposit type of account which pays 3.5% (4% minus 0.5% admin charge) and this is returned to the customer after the completion of 5 years. After 5 years, you can make partial or total withdraws without any fee but it would be foolish to do so. Overall, you are stuck for at least 15 years if you want to recover some of the charges and reap any benefit.
Riders:
You are forced to purchase mandatory riders for disability and dismemberment. These add up to a mostly wasted premium of around 5k per year for 10 years.
GST:
You end up paying GST charge of 4% which translates to around 8k per year for 10 years.
Positive Factors
Free unlimited switching:
You can switch your fund and future premiums from one fund type to another, including bond funds. You can do this fully or in any mix of percentages. For example, if you are in fund X at 100% allocation, you can move 50% to bonds and 20% to Fund B and 30% to fund C and so on. There is no fee and you can do this as often as you like. In case of a downturn in the market, you can move your corpus to a bond fund and wait it out without having to liquidate and pay tax like you would in a normal mutual fund.
Tax advantage:
The entire gains would remain tax free. This directly provides a 12.5% current and likely a 20% future tax benefit as tax on equity is bound to rise. On an 80 lakh corpus, we are talking about 16 lakhs in tax benefit. Even a 50 lakh corpus means 10 lakhs saved at the likely 20% tax rate. Even at current tax rate, you would save 6 to 10 lakhs.
Insurance component:
Personally, 50 lakhs isn't a large amount for me. However, this sum insured of 50 lakhs for life and disability, can be a reasonably significant amount for some people. In which case, they can enjoy an additional benefit.
Premium payment rewards:
Using my Biz Black, I can get 16.5% cashback on premium payment! Using Infinia and Amazon Pay, I can get around 12% and using SBI Cashback Card via Apay, I can get 5% cashback. This isn’t possible in normal mutual fund investment. The premium can be paid annually, quarterly or monthly. 16.5% cashback on my annual premium is a cool 36k which more than makes up for any opportunity cost loss.
Refund of Fund Maintenance Charges:
All charges collected during the tenure are refunded at the end. This can easily become a nice sum of 10 to 15 lakhs in refund, depending upon your corpus value. For example, if your corpus were valued at 60 lakhs, the maintenance charge for the year would be 81k. The 8% illustration shows a refund of over 10 lakhs. If the fund grows at 12 or 16%, the corpus would be much larger and this refund would be even higher.
Helps improve relationship with the bank:
Bankers love ULIPs due to high charges and it can help you become a more premium customer and can lead to some benefits.
Conclusion:
A ULIP is only worth it if it is held for at least 15 plus years. If you look at its performance in the first year or two, it will be abysmal due to the high allocation plus mortality charges. So the first 5 years are bound to show a terrible picture and most people become disheartened and give up. It’s only after the 2x refunds start getting added starting from the 10th year when you would start seeing good performnce. The long lock in period is a negative but, in a way, it helps by ensuring that you are invested for the long run. I would welcome comments and discussion. The figures as well as the refund of charges is taken from the policy document and is guaranteed. So, please don’t come up with arguments like, ‘they are lying, they won’t refund anything’ as it is an official contract document. It’s like having a fixed deposit at the rate of 8% and arguing that the bank won’t actually pay. We can discuss other aspects such as the loss due to opportunity cost and so on. In general, you can do better with a mutual fund as it provides flexibility without any long lock in period.
Key Factors:
Negative Factors
Premium allocation charges:
These are collected typically for the first 4 years and are as follows:
12% for 1st year
6% for the 2nd year
4% for the 3rd year
3% for the 4th year
None from the 5th year onwards
NOTE: these charges are refunded 2X (double the amount paid) after 10 years. The charges collected in the 1st year are refunded via addition to the fund in the 11th year and the charges collected in the second year are refunded in the 11th year and so on. So we can sort of assume that we are allocating a portion of our investment in a fixed deposit that would double it in 10 years with a tax equivalent yield of 11% for this portion. However, there is some lost opportunity cost here.
Mortality charges:
These are the most insidious and perhaps the most harmful aspect of a ULIP. These charges vary by age and are collected daily by selling off your NAV units. There is a specific formula approved by IRDAI which is used to Calculate these charges. The older you are, the higher the charge and the higher the sum assured, the higher the charge as well. As a rough example, for a 30 year old, with a 50 lakh sum assured, this charge would be 0.8305 per 1000 of sum assured. This would translate to Rs 4152 annually. For a person at age 40, the charges would be 1.4280 per 1000, which would be 7140 per year. As you get older, these charges shoot up dramatically. At 50, you would pay 18853 per year, at 60, Rs 47438 and at 70 years old, you would pay a horrendous 1.02 lakhs per year!
See below as well.
Silver lining:
Firstly, these charges are imposed on the amount at risk for the insurer. The policy pays the sum insured or your corpus balance, whichever is higher (sum at risk minus fund value). When your corpus is zero, the insurer is bearing the risk for the full 50 lakhs and these charges would be calculated on full 50 lakhs sum insured. When your corpus has grown to 10 lakhs, the sum at risk is now 40 lakhs and the charges would be claculated on 40 lakhs value. When your corpus reaches 20 lakhs, the charges are based upon the remaining 30 lakhs value and if and when your corpus reaches 50 lakhs, the charges become zero. So the hope is that your corpus grows quickly to 20 to 30 lakhs in 10 years in order to reduce these charges as you grow older. The illustration at 8% growth (maximum permitted by IRDAI) shows that corpus at 25 lakhs at 10 years and 50 lakhs at around 18 years. However, the funds have grown historically at 26% and one can assume that one wouldn’t have to pay mortality charges after about 15 years unless there is a very long downturn the stock market.
Refunded at 2X. Even better feature is that these mortality charges are refunded back at 2X the amount paid starting from the 10th year. This is done by adding units monthly just as they were deducted. So, once again, we can assume that we are dedicating a portion of our investment to a fixed deposit that would double it in 10 years tax free.
Policy administration charge:
This is capped at 6k per year with no charges for the first 5 years.
Fund management charge:
This is 1.35% per year which is similar to most non direct mutual funds.
NOTE: These charges are fully refunded (1X) at the end of the policy term. So there would be a fairly large addition of 10 to 30 lakhs at the end to the corpus depending upon its total value.
Lock in period:
There is a minimum 5 year lock in period. You can surrender you policy earlier with a fee of 3k for the first year which falls to 1.5k in the 3rd year. When you surrender it before 5 years, the corpus amount is transferred to a fixed deposit type of account which pays 3.5% (4% minus 0.5% admin charge) and this is returned to the customer after the completion of 5 years. After 5 years, you can make partial or total withdraws without any fee but it would be foolish to do so. Overall, you are stuck for at least 15 years if you want to recover some of the charges and reap any benefit.
Riders:
You are forced to purchase mandatory riders for disability and dismemberment. These add up to a mostly wasted premium of around 5k per year for 10 years.
GST:
You end up paying GST charge of 4% which translates to around 8k per year for 10 years.
Positive Factors
Free unlimited switching:
You can switch your fund and future premiums from one fund type to another, including bond funds. You can do this fully or in any mix of percentages. For example, if you are in fund X at 100% allocation, you can move 50% to bonds and 20% to Fund B and 30% to fund C and so on. There is no fee and you can do this as often as you like. In case of a downturn in the market, you can move your corpus to a bond fund and wait it out without having to liquidate and pay tax like you would in a normal mutual fund.
Tax advantage:
The entire gains would remain tax free. This directly provides a 12.5% current and likely a 20% future tax benefit as tax on equity is bound to rise. On an 80 lakh corpus, we are talking about 16 lakhs in tax benefit. Even a 50 lakh corpus means 10 lakhs saved at the likely 20% tax rate. Even at current tax rate, you would save 6 to 10 lakhs.
Insurance component:
Personally, 50 lakhs isn't a large amount for me. However, this sum insured of 50 lakhs for life and disability, can be a reasonably significant amount for some people. In which case, they can enjoy an additional benefit.
Premium payment rewards:
Using my Biz Black, I can get 16.5% cashback on premium payment! Using Infinia and Amazon Pay, I can get around 12% and using SBI Cashback Card via Apay, I can get 5% cashback. This isn’t possible in normal mutual fund investment. The premium can be paid annually, quarterly or monthly. 16.5% cashback on my annual premium is a cool 36k which more than makes up for any opportunity cost loss.
Refund of Fund Maintenance Charges:
All charges collected during the tenure are refunded at the end. This can easily become a nice sum of 10 to 15 lakhs in refund, depending upon your corpus value. For example, if your corpus were valued at 60 lakhs, the maintenance charge for the year would be 81k. The 8% illustration shows a refund of over 10 lakhs. If the fund grows at 12 or 16%, the corpus would be much larger and this refund would be even higher.
Helps improve relationship with the bank:
Bankers love ULIPs due to high charges and it can help you become a more premium customer and can lead to some benefits.
Conclusion:
A ULIP is only worth it if it is held for at least 15 plus years. If you look at its performance in the first year or two, it will be abysmal due to the high allocation plus mortality charges. So the first 5 years are bound to show a terrible picture and most people become disheartened and give up. It’s only after the 2x refunds start getting added starting from the 10th year when you would start seeing good performnce. The long lock in period is a negative but, in a way, it helps by ensuring that you are invested for the long run. I would welcome comments and discussion. The figures as well as the refund of charges is taken from the policy document and is guaranteed. So, please don’t come up with arguments like, ‘they are lying, they won’t refund anything’ as it is an official contract document. It’s like having a fixed deposit at the rate of 8% and arguing that the bank won’t actually pay. We can discuss other aspects such as the loss due to opportunity cost and so on. In general, you can do better with a mutual fund as it provides flexibility without any long lock in period.
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