I am often asked this question, isn’t investing in ULIPs smarter there are lower taxes and there is also life insurance cover? The short answer is that a Unit Linked Insurance Plan is not a great option when it comes to building wealth.
Here are 3 Reasons, read on for more to see the “proof”:
- Commissions that are deducted upfront are significant. These may appear as “Premium Allocation Charges”.
- More charges – In addition you have other charges such a policy admin charges, fund management charges making the policy costly compared to a direct plan mutual fund. You also incur GST on all the charges!
- Compounding takes a hit as with all these charges, you start with a smaller base.
Insurance & Investment
The confusion largely comes from mixing ‘life insurance’ with a ULIP and calling it a better ‘investment’. You are better off buying term life insurance and investing the rest in a good mutual fund.
You may hear things like: “But you don’t get anything back by buying term life insurance” – the cost of term life insurance is only a few hundred/thousand rupees per year. Whereas the costs embedded in a ULIP are far higher!
Lets take an example. As per the regulator a ULIP can show only 8% yield in an illustration. We will use that for now. Assumed investment: Rs 2 lakhs per year for 5 years.
After taking into account various charges, the investor ends up with about 14.7 lakhs after 10 years. That may seem a big amount but the net yield is only about 5%. He was promised 8% but after charges he gets only 5% or less.
The various charges investor incurs are:
- Premium allocation charges – 2% per year of investment or more usually much higher is taken out.
- Policy admin charges
- Mortality charges
- Taxes i.e. GST at 18%
- Fund management charges
As a result the net yield drops.
This gets worse if you wish to withdraw your money as soon as the lock in period of 5 years ends. You get a measly 1% net (see pic below on 5 year XIRR).
What about Mutual Funds?
If you consider the same investment in a Mutual Fund you get a net yield of 7.37% instead of 4.92%.
- This is after deducting a one shot amount of Rs 26,840 in year one to purchase a term life insurance policy.
- Normally you would pay RS 4000 each year and I have considered the net present value of 10 years term life insurance premium in Year 1 for a 45 year old person (whose premium cost is usually much higher than a 25 year old). The math would be be similar.
- This also considers 10% Long term capital gains (LTCG) at the end of 10 years. Note that the LTCG can be significantly reduced by staggering withdrawals over years and by investing on behalf of various family members. But we will take a conservative view on taxes.
The above illustrations are based on 8% yield.
Isn’t 8% too low? How Does this show up with higher returns
If you consider higher return scenarios, then the following picture emerges. I have considered some of the multicap funds using their actual 5 year returns as of July first week 2018. As you can see for the same investment, you get much more with Mutual Funds.
Of course these are Direct Plans only (best selection available on Jama.co.in) – do not make the mistake of not buying direct plans. Your broker/advisor/distributor may not want you to go for direct plans as they do not get commission.
Mutual Fund SIP along with Life Insurance
Now a days Mutual Funds are also offering insurance cover along with the monthly SIP. Taking that into account (we do not reduce the first year investment to purchase term life insurance) your net corpus could be higher by about 2% to 3% more.
As they say in Hindi, “Doodh ka doodh, Paani ka Paani”. Now you decide.
Note: You are advised to consult your financial advisor or insurance agent before making any final decision on going the ULIP route or invest in Mutual Funds.