ULIPs - To buy or not to buy!

Mar 5

3 min read

Updated: May 3

Are you in a rush to buy a ULIP (Investment + Insurance plan) just to save on some tax? Let's first check whether or not the cost-to-benefit analysis works out for you.

Before we proceed, here is the formula to calculate the ULIP plan fund value on any given day:

Fund Value = Current Unit Balance x Current NAV per Unit

Next, look at the brochure and benefit illustration of the plan you are interested in and review the details of applicable charges.

Charges of the ULIP plan would either be deducted from the unit balance or the NAV, and both will have the effect of reducing your fund value. The rate of return is calculated based on the NAV and not the unit balance. Hence, if charges are deducted by reducing the unit balance, it will not reflect in the illustrative rate of return. What this means is that even though the rate of return may appear higher in this case, your fund value actually gets reduced as per the above formula because those charges have been deducted by reducing the unit balance.

In the plan documents, you will typically find the following charges:

Fund management charge: This is restricted to the limit imposed by the regulator and generally will not exceed 1.5% of the fund value in a year. This charge is usually deducted from the NAV of the fund itself, so it would be reflected in the illustrative rate of return shown.
Policy administration charge: This is charged at about 0.15% of the fund value per year on an average and is normally directly deducted from your unit balance. So, this charge would not be considered in the rate of returns shown to you.
Mortality charge: Such plans come with in-built mandatory insurance cover and this is the charge that goes towards paying for your insurance coverage. So, it will generally depend on your age and coverage term as usual. This charge is also normally directly deducted from your unit balance and therefore would not be considered in the rate of return shown to you.
Allocation charge: This is what we need to pay the most attention to. This charge is deducted on every installment paid BEFORE investing the balance into the market-linked fund of your choice. And these charges can be as high as 5% to 7% of the amount invested! So, the rate of return in the illustrations shown do not account for this charge, as they are never part of the fund value at all.

How can we know the effective rate of return of the entire ULIP plan? Here's a simple way to do it. Take the provided illustrative benefits over your intended term and input all the given investment installment values and the final payout value, along with the respective dates into an Excel sheet. After this, use the XIRR function to arrive at the effective rate of return over this duration. And then you can decide whether it is really worth taking the market risk for those kind of returns. The same evaluation process can be applied even to Endowment policies, which also are plans that combine investment returns with insurance cover.

Let's take an example for understanding how to compute XIRR. Assume you have invested ₹ 2.5 Lakhs every year for 5 years and at the end of the 5th year, you intend to get the illustrated surrender value of ₹ 14 Lakhs as the final payout. So, your calculation table in Excel will look like this (Note that amounts paid are to be entered as negative and amount received is to be entered as positive as per the specifications of the XIRR function)

Here, the value of 3.8% is calculated for this duration using the XIRR formula in cell B9 as:

=XIRR(B2:B7, A2:A7)

You can use the values for your specific case from the benefit illustration of the plan that you are interested in, to see how the effective rate of return looks like for you.

So, what can you do if you are not happy with such returns? A better alternative if you want both investment returns and insurance cover, is to go for them separately and do that in a cost-effective and tax-efficient way. Also, it is important to get a trusted advisor to put together a solution customized to your requirements. An advisor who reads the fine print of the plans on offer, one who does all the calculations and presents the facts in a transparent manner to you. One who puts you, the investor first!