Why ULIPs are not a great investment

By Morningstar |  04-02-21 | 

The Union Budget 2021 brought about a significant change in the taxation aspect of ULIPs. With the doing away of the tax-free nature of the maturity amount, they are bound to lose a bit of sheen.

Registered Investment Adviser Dev Ashish throws more light on this issue. Here are his thoughts.

Where ULIPs scored over equity funds.

A ULIP is an acronym for Unit Linked Insurance Plan. It is a product offered by life insurance firms, that combines insurance coverage and investment exposure.

ULIPs began to gain prominence after the reintroduction of long-term capital gains (LTCG) tax on investments in equity and equity-linked instruments. For many years, gains on equity investments held over a year were free from capital gains tax. Union Budget 2018 introduced a 10% LTCG on equity, for gains above Rs 1 lakh.

Let’s say you invested Rs 1 lakh and it earned you 12% per annum. After 20 years, the value of your investment would be Rs 9.64 lakh. Once you take away the LTCG, the amount you receive will be Rs 8.88 lakh. Which effectively brings down the CAGR from 12% to 11.54%.

To get a better perspective, let’s look at the impact of LTCG on an investment of Rs 50 lakh. That amount will become Rs 8.5 crore after 25 years, with a CAGR of 12%. Once LTCG comes into the picture, the amount drops to Rs 7.7 crore (CAGR: 11.56%). A difference of almost Rs 80 lakh.

Now the ground is even.

Union Budget 2021 declared that ULIPs will be taxed just like mutual funds, if the annual premium exceeds Rs 2.5 lakh. The maturity proceeds in such a case, will no longer be tax free but subject to tax in a similar way that mutual funds are taxed. As a result, they no longer offer the tax arbitrage.

DO NOTE. Only the gains on maturity amount of ULIPs, arising from redeeming the units of ULIPs with a premium of or above Rs 2.5 lakh would be taxed. However, there will be no tax if exit is due to death of ULIP policyholder.

Why was this done?

ULIPs are hybrid products that combine insurance and investment in equity and debt. But they have primarily been sold as equity investment products in the past. After equity was subject to tax in 2018, ULIPs had an undue advantage in the form of exemption under Section 10(10D).

To avail of this tax arbitrage, many high net worth individuals were attracted to this tax-free status over the last few years and began investing in equity via the ULIP route. This way, they were exempt from capital gains tax. With the tax exemption pulled out, ULIPs are no longer that attractive.

This will also curb mis-selling to some extent. ULIPs have been aggressively sold (or pushed) on the premise of combining investment with insurance, ‘claimed’ equity-like returns and tax-free status (till now). But very few ULIP agents or banks were honest enough to explain the full details and actual return profile of ULIPs. With no tax-free maturity benefit, at least one part of the sales pitch is correctly handled.

Should you consider ULIPs?

I have long maintained, and never wavered, that individuals should not mix insurance with investments. This includes ULIPs, endowment plans and moneyback policies.

If an individual gets a proper term insurance coverage, ULIPs serve no purpose as insurance products. I find them to be opaque and poorly performing investment vehicles. Not to mention expensive, as one ends up paying lakhs of rupees in annual premium.

Get your insurance needs assured with term insurance plans. When it comes to your investments, there are plenty of options out there that offer transparency. Equity funds, debt funds, stocks, Employee Provident Fund, Voluntary Provident Fund, Public Provident Fund, and so on and so forth.

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ninan joseph
Feb 4 2021 03:27 PM
 Fully endorse the author's view.

Almost all RM of a Bank will try to sell you a ULIP product - the new theme is that interest rate is falling and this is a great product.

Term Insurance, Emergency Funds, Medical Insurance and then Invest.
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