Unit linked insurance plans or ULIPs are perhaps the most versatile financial instrument available today, offering a combination of investment and insurance in one product. However, while investing in a ULIP, the premium payment term is perhaps the biggest consideration. Its impact on returns from a ULIP warrants an understanding to make intelligent investment decisions.
What is a ULIP?
ULIPs are hybrid products that, other than providing life cover, offer investment in different financial instruments, such as equity, debt, and so on, or balanced funds. Premium is used partially to meet life cover and the balance is invested in funds chosen by the investor, which may grow in value over a time period due to respective funds’ performances.
The key benefits of ULIPs are that:
- Double Benefit: Your life insurance earns investment growth.
- Tax Efficiency: The tax benefits are availed under Section 80C, and the returns are tax-free under Section 10(10D), subject to conditions.
- Flexible Investment Options: Policyholders can transfer between various funds depending on their risk appetite and market conditions.
- Long term growth: ULIPs are invested for long term and, henceforth, benefit from compounding power.
Understanding Premium Payment Terms in ULIPs
The Premium payment term in a ULIP is the duration for which the policyholder agrees to pay premiums. Premium Payment Terms can be of two kinds:
- Level Premium Pay: A fixed number of years is for the payment of premiums that can be for 5, 10 or 20 years. From this point, the policy can continue with the funds invested, and no further premiums are charged.
- Level Premium Paying: The policyholder pays premiums for a definite period, and after such period the policy continues, and there is no further premium payment, but the insurance cover is in force.
- Single Premium Payment: The premium should be paid in a single amount, and no more premiums pay after that.
Effect of Premium Payment Terms on ULIP Returns
The premium payment term significantly impacts the returns on ULIPs in several ways. Let’s explore these impacts in detail.
1. Time Horizon and the Compounding Effect
Compared to the limited or single premium payment term, a longer premium payment period means that over time, a large corpus can be built up. The longer one pays premiums, the more potential he has for his money to gain in value over time through the compounding effect. A limited or single premium payment term would result in the investment amount being less; the compounding effect might not be as strong either.
For instance, for a level premium policy with 10 years tenure, all the investments in such tenor will compound for the entire tenure of the policy. But if one pays the premium as single and one time at the inception then one can see growth for further years ahead, but here also the compounding will not be that aggressive since one will pay normal/limited premiums.
2. Impact on Risk Appetite and Fund Choices
The amount and the quantum of the premiums determine the risk profile for the investor. The cash inflow stream in case of regular premium ULIPs is ascertainable and constant but can be invested in riskier assets, such as equity, which would have a possibility of working out better in the long term. With limited or single premium payments, upfront investment has to be risk-averse. In that case, therefore, the funds placed would normally be conservative with a debt or balanced fund concentration.
A regular premium allows for increased choice flexibility from equity or hybrid funds, which are inherently more likely to yield higher returns over time, especially in a rising market.
3. Charges and Fees
One of the major concerns with ULIPs involves charges accompanying the policy, including the following:
- Premium Allocation Charge: A percentage of the premium that goes directly before investment.
- Fund Management Charges: The charge is that of managing the funds in which the premiums are involved.
- Mortality Charges: a charge levied for the life insurance cover taken under the ULIP.
Since premium payment terms are normally with regular premiums, allocation charge on premium is spread over a number of years. Thus the above charges have no impact over long period of time. In the case of limited premium payment, the policyholder also benefits from lower administrative fees during the after-period of paying premiums, thus enhancing net returns.
4. Liquidity and Flexibility
The cost of the premium payment term also affects the liquidity and flexibility of the investment. ULIPs in regular premiums allow an investor to continue his or her contributions; therefore, investors can increase their investments in favorable market conditions.
Limited and single premium ULIPs tend to be a bit more flexible once the premiums have been paid. Once paid into, there is no further obligation to pay premiums, but these plans generally require a bigger one-off investment upfront. That could be an attractive option for a one-time commitment.
5. Surrender Value and Partial Withdrawal
The surrender value of a ULIP is the amount which a policyholder gets if he wishes to withdraw from the policy before maturity. Such value is worked out by investment amount, the term for which the premium amounts have been paid and the performance through the underlying funds.
In unit-linked regular premium plans, the surrender value may not be considerable in the initial years considering that contribution charges are more. Over the period of time, as premium becomes paid, the generated fund amount increases.
The Role of ULIP Calculators
This is where the online ULIP calculator comes into play, first to understand how varied premium payment terms will impact your ULIP returns. A ULIP calculator enables an investor to input different parameters like the premium amount, premium payment term, investment duration, fund allocation, and even expected rate of return.
Some benefits of using a ULIP calculator are:
- Estimate Returns: A method to approximate the expected returns through a calculation relying on historical information or current market assumptions.
- Compare plans: Compare the returns of various ULIPs with different premium payment terms and investment options.
- Plan customization: Increase or decrease the premium payment term or change the type of fund to make it look how it would change your returns.
With a ULIP calculator, you will be able to understand what it is that different premium payment terms do to your accumulated investment amount so that you can tailor your plan in relation to your financial goals.
Conclusion
The other big factor while choosing the amount to invest is the premium payment term. This makes it easier to decide on your returns for the long term. Whatever you may choose-regular, limited, or single premiums-each term has its benefit as well as challenges to be able to enjoy them. More useful for long-term compounding and investment in riskier asset classes will be regular premiums. Options for limited and single premiums are going to offer a little flexibility and lesser obligation on payments.
