Financial planning is one of the most important decisions that an individual has to make, especially if they have dependents. While most people need life insurance, they also want investments that generate returns. This is why Unit Linked Insurance Plans (ULIPs) entered the market. ULIPs are two-in-one financial instruments that provide both insurance and investment. When you buy a ULIP, the premiums that you pay are allocated into two parts. One part of the premium you pay is allotted towards your life cover, while the other part is invested in funds of your choice. You can choose the funds that you want to invest in based on your risk appetite.
Once you have purchased a ULIP policy, you get the life cover along with returns on your investments. However, after some time, due to personal or financial reasons, you may want to exit your ULIP. Depending on when you want to surrender your ULIP, the impact will vary. Most ULIP plans have a lock-in period of five years. Depending on when you exit by surrendering, the repercussions will vary.
Surrendering before five years
When you purchase a ULIP, the premiums that you pay provide life cover and investment benefits. However, surrendering a ULIP within five years would mean an erosion of the premiums paid before. Therefore, it is recommended that you should not surrender your ULIP before the end of the lock-in period. When you choose to surrender your ULIP before five years, the amount that the insurance company needs to pay you will be received only after the five years have ended. Also, you will not receive the fund value that exists on the date of surrendering.
Once you have applied to surrender your ULIP policy, the insurance company will deduct certain discontinuance charges and the remaining balance will be moved to the Discontinued Policy (DP) fund. When your money is in the DP fund, the insurance company may also levy a fund management charge. It cannot be over 0.5 per cent of the fund amount. Your money in the DP fund will continue to earn interest, as insurance companies are liable to provide a minimum guaranteed return from time-to-time. Usually, the DP funds offer annual interest of 4 per cent.
Surrendering after five years
When you exit a ULIP after the lock-in period of five years, you can withdraw the fund value without having to pay any exit charges. However, remember that the returns you withdraw today are likely to be way less than what you would receive if you stayed invested for 15-20 years. This is because ULIPs are designed as long-term products and offer maxim benefits in the long haul. Hence, exiting early would lead to the letting go of untapped ULIP benefits and returns.
Why should you hold on to your ULIP?
There are several reasons a policyholder may want to discontinue their ULIPs before or after the lock-in period. However, it may not be the best decision from a financially perspective. To reap the maximum benefits of your ULIP investments, you need to stay invested for the long haul.
Here are some reasons why you shouldn’t surrender your ULIP:
● ULIP is a financial instrument that offers tax benefits on multiple levels. On the premiums that you pay for your ULIP, you can claim a deduction on those under section 80C of the Income Tax Act. One can claim up to 1.5 lakh deduction annually under this section. Also, ULIP offers tax-free maturity and death benefits, as they are both subjected to tax exemptions under Section 10 (10D) of the Income Tax Act.
● ULIPs are directly subjected to market risks where one can invest in equity-based funds directly. Over the long haul, equity funds have provided great returns, and it is most likely that the longer you stay in them, the more money you will make.
● Surrendering a ULIP within the lock-in period would lead to the loss of ULIP benefits on two fronts. The life insurance part of the ULIP will also be discontinued when one surrenders, leaving the policyholder without a safety net. Also, the policyholder cannot withdraw the funds within five years. Additionally, there are various charges one may have to pay for surrendering before the lock-in period.
It is advisable to continue with the investment in ULIP for a long duration to benefit from the returns that would further help you meet your long-term financial goals. It also provides tax benefits and the longer you are in it, the more you will benefit from the compounding of your investments.
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