ULIPs & You – Insurance in Financial Planning
Personal financial planning is a process of identifying your short term & long term financial needs. It involves translating financial needs or goals into monetarily measurable goals according to your priorities at different stages of the life cycle.
A financial planning exercise ensures that you have the right amount of money at the right time to meet your financial goals. So, to enable this, a financial planner incorporates analytical study while preparing a balanced and realistic financial plan to meet your financial goals after considering:
- Financial resources (present as well as future) available
- Stage of life
- Risk profile
- Current lifestyle
Financial planning covers all areas of your financial needs and helps you to achieve each of the goals. The scope of planning broadly includes the following:
- Risk planning: It includes life insurance, health insurance, general insurance (like motor insurance, house insurance) etc.
- Life insurance plan helps in protecting your family, in case of your untimely death; which may have an impact on your family’s finances.
- Health insurance takes care of medical & hospitalization expenses and loss of income during illness period.
- General insurance covers major expenses like repairs of house, motor etc which got damaged due to natural disaster, accident etc.
- Wealth (investment) planning: It includes managing investments to generate future capital and cash flows which can be utilised for spending as well as investing. This activity comprises of tax planning, investment planning, estate planning etc. So, your financial goals can be achieved through proper diversification across various asset classes and financial instruments such as mutual funds, gold, real estate, fixed income securities, equities, ULIPs etc.
- Retirement planning: It ensures you financial independence during your sunset years. There are host of factors such as present age, age of retirement, present risk profile, present incomes and expenditures along with future value of expenditure and income needed to sustain etc., to be considered while doing retirement planning exercise. Taking into consideration these factors your investment avenues are selected, which will enable you to take care of the sunset years.
Your Financial Planner will undertake a structured analytical study for you which will take into account the factors such as your age, annual income, financial situation and needs, investment objectives, intended use of the policy benefits/returns, financial time horizon, existing assets and insurance policies, liquidity needs, risk appetite, tax status etc., in the planning exercise.
ULIPs in Financial Planning
A ULIP is a long term investment-cum-insurance product, which takes care of investment as well as insurance needs. However, investment in ULIPs would be prudent (as it creates wealth), only if you hold it for a long term. This product will make less economic sense, if you intend to meet your short-term financial goals with it.
But, with attractive commissions filling the agent’s pockets, ULIPs easily qualify as both the most popular and the most mis-sold product. Speak to your Financial Planner (who is hopefully fee based and not commission driven) when dealing with a ULIP. Your Planner will be able to assess your existing insurance portfolio, tell you if you’ve been mis-sold an insurance policy, and give you a solution that will fit into your financial plan. Your Planner will probably ask for policy details such as term, premium, type, sum assured, fund value, surrender value and so on, before recommending that you either surrender or continue with your ULIP.
Taxation of ULIPs
From the tax planning perspective, at present investments in ULIPs enjoy an Exempt Exempt Exempt (EEE) status. The premium contribution of upto Rs 1 lakh in this product enjoys tax benefit under Section 80C of the Income Tax Act, 1961. And similarly withdrawals at maturity are exempt from tax payments, under section 10(10D) of the Income Tax Act.
However going forward, if the Direct Tax Code (DTC) goes through, ULIPs could come under the Exempt Exempt Taxed (EET) regime and hence, be taxed at the time of maturity.
Should you include ULIPs in your financial planning exercise?
To answer this, you should properly assess your financial goals. Depending upon your goals and liabilities respective financial instrument should be used, while doing your financial planning exercise. ULIPs would only be suitable, if it all, for very long term goals i.e. 10-15 years hence. Moreover, you may consider investing in ULIPs, after having primarily indemnified your life risk, through pure term insurance plans.
Also note that ULIPs were created as long term products, stated to outperform mutual funds in the ‘over 10 year’ investment horizon. But ULIPs haven’t been around for 10 years yet, so there is no historical basis on which to compare the two instruments i.e. mutual funds and ULIPs, so as to check the validity of the statement.
What does IRDA as a regulator need to do?
At present Insurance Regulatory and Development Authority (IRDA) has issued new guidelines for ULIPs to make them more attractive for policy holders. These guidelines have definitely improved the ULIP product in terms of reducing various charges like surrender charges, upfront charges, overall charges; increase in lock-in-period, disclosure of agent’s commission, setting up of investor grievance redressal system etc.
But, despite all the changes announced, these products still have a long way to go on transparency and disclosures relating to their investments.
In our opinion IRDA needs to:
- Properly implement the new guidelines
- Eliminate mis-selling completely
- Infuse more transparency in products, through better disclosure norms
- Increase investor awareness about their insurance needs
- Removal of health/insurance cover on pension plans to maximize maturity benefits because mortality charges of the health insurance will erode the corpus
- Soften sale targets for agents (currently set at 20 insurance policies with the minimum premium amount of Rs 1.50 lakh p.a.) which will thus reduce the cases of mis-selling
- Set-up effective investor grievance redressal machinery
The IRDA needs to become a more credible and acceptable machinery which would address all the issues relating to insurance and insurance products. It should assume more responsibility towards protection of investor’s interest and try hard to make ULIPs a more investor friendly product.
Once these changes are made and ULIPs prove themselves over a longer than 10 year horizon, you and your Financial Planner can definitely consider including them as part of your Financial Planning exercise. Until then, our stance remains the same.
Take pure term insurance for life cover, and keep your insurance and investments separate.