Life insurance is an essential aspect of any financial portfolio. It helps you breathe a little easier as you are assured that if any unfortunate event were to occur with you, your loved ones will not suffer any financial difficulties. To meet the varying needs of policyholders, insurers have launched different types of life insurance policies. One product that has caught much attention is the ULIP plan or Unit-Linked Insurance Plan. The unique feature of ULIPs is that they offer a chance for the investor to invest in market instruments along with life insurance coverage. Are you wondering which policy would be more suitable for you, a ULIP or a traditional life insurance policy? This article can be of help to you.
How does a traditional life insurance policy work?
Traditional life insurance offers a single benefit: if the policyholder passes away in a manner specified in the policy, the beneficiaries receive the sum assured chosen by the policyholder. To fund this sum assured amount and to ensure the continuance of the policy, one must pay premiums on a regular basis.
How does a ULIP work?
Like in traditional life insurance, you also have to pay a premium for ULIPs. However, this premium does not simply include life insurance coverage. A portion of the premium is also used to invest in market instruments. These instruments can be of various types, as per the risk profile of the investor. Equity funds are suitable for investors with a high risk-taking capacity and debt funds for those who are a bit risk-averse. If you have a balanced portfolio, then you will get to invest in hybrid funds. To understand how fund types affect your returns, you should use a ULIP plan calculator.
Besides this main distinguishing factor, there are many other differences between a ULIP and traditional life insurance. A look at these factors can help you reach the right decision.
Traditional life insurance Vs ULIPs
Risks and returns
There is no market risk element in a traditional life insurance policy. Since the entire amount goes into building the life insurance corpus, one does not have to worry about how the market fluctuations will affect your money. But with no money being invested in the market, there is no scope for returns as well. The only monetary compensation is the sum assured that your family will receive in your absence.
In a ULIP plan, the risk factor varies as per the kind of fund you have chosen. Debt funds incur low risks while equity funds incur a higher amount of risk. As with any other investment avenue, more risks mean more returns. Thus, your ULIP NAV (Net Asset Value) increases when you invest in equities and may be lower when you invest in debt options.
Charges and penalties
In a traditional life insurance policy, the majority of the premium goes towards paying the mortality charges. This is what creates the life insurance corpus amount. There are a few other charges; however, these are fairly low in amounts. Traditional life insurance does not have major penalties, either.
ULIPs have various charges, such as:
- Premium allocation charge
- Fund switching charges
- Premium distribution charges
- Mortality charges
- Policy administration charges
Some of these are taken from the premium, while some are deducted while calculating the ULIP NAV. Insurers may levy penalties if the policyholder does an action such as withdrawing before the end of the lock-in period, withdrawing more than the upper limit allowed, etc.
Note that while IRDA has upper limits on ULIP charges, there is no such capping on the charges of traditional life insurance.
Both traditional life insurance and ULIPs allow the policyholder to claim tax deductions up to Rs 1.5 lakhs against the policy premiums. Section 80C of the Income Tax Act, 1961, has laid down the rules for this tax deduction.
The death benefit pay-out from a traditional life insurance policy is tax exempted. In the case of ULIPs though, it is not only the death benefit pay-out but also the surrender value pay-out and the maturity benefit pay-out that are tax exempted. Even the partial withdrawals from your ULIP plan are tax exempted.
These were some major points of difference between traditional life insurance and ULIPs. These points clarify to a great extent that if you are simply looking for the future security of your family, traditional life insurance is the right option. However, if market-based returns are something you are looking for, then ULIPs are the better option. Do use tools such as the ULIP plan calculator to get an estimate of those returns.