ULIPs: Should You Hold or Surrender?

If you had purchased a Unit Linked Insurance Plan (ULIP) last year and paid INR 35,000 for the premium, you might be wondering whether it makes sense to continue with the plan for the next four years or to pay a surrender charge and get out. Your decision depends on the rationale behind your initial purchase. Below, we will explore various factors to help you make an informed decision.

Understanding ULIPs

User ULIPs are financial products that combine the aspects of insurance and investment. They allow policyholders to get life insurance coverage and also invest in a fund managed by the insurer. While they can be attractive at first glance, it's crucial to understand the nuances of these products before making a decision. Many people find themselves in a bind when they realize the terms and conditions associated with ULIPs do not align with their expectations.

Which Reason for Purchase?

The first step in the decision-making process is to identify the reason for purchasing the ULIP. If your primary reason for the purchase was insurance, then you should continue with the plan for the next 25 years. However, if your purpose was purely to invest, you may have made a serious blunder. Anything that comes with insurance features is not typically a sound investment strategy.

Investment Considerations

Without a doubt, if your primary purpose was investment, it is highly advisable to surrender the policy and invest the proceeds in direct mutual funds. Direct mutual funds often offer better returns in the long term, especially for investors with a 15-year or longer horizon. It is important to note that ULIPs are heavily influenced by the stock market, and the returns they offer are often poor unless you invest in hybrid or debt funds.

In ULIPs, approximately 10% of the premium is deducted every year under different heads, such as policy management charges, administrative fees, and other miscellaneous expenses. This can significantly eat into the returns you would expect to generate from the investment. Therefore, it is unlikely that your investment will break even unless the stock market delivers a return of at least 20%. Over the long term, this can result in a net value that is less than the amount you have invested.

Surrender Fee and Timing

Surrendering the policy and incurring a 6,000 rupee surrender charge might be a better option than continuing with the plan. The surrender charge serves as a penalty for early termination and is designed to cover the insurer's costs and other expenses. It is important to weigh the surrender charge against the potential returns you could have achieved from an alternative investment.

Another factor to consider is the investment flexibility. With ULIPs, you are required to pay premiums on specific dates, regardless of the market conditions. If the market is down, you are penalized for not timing your investments correctly. However, in mutual funds, you have more flexibility to buy or sell units based on market conditions.

Long-Term vs. Short-Term

ULIPs are generally recommended for a long-term investment horizon of at least 15 years. For those under the age of 35, ULIPs can offer relatively good risk coverage and lower mortality rates. However, the risk-benefit ratio is poor compared to term insurance policies. These policies offer a maximum of one premium, and your risk is covered by the fund value, which can be achieved within a few years.

Moreover, the ULIP scheme does not offer a fund value death benefit in many cases. Earlier, ULIPs did offer this benefit for some plans, but now they only offer one or the other. Therefore, if you are looking for a robust insurance product with a good risk-benefit ratio, you might want to consider a term policy instead.

In conclusion, if your primary reason for purchasing the ULIP was for insurance, it is advisable to continue with the plan for the next 25 years. However, if your primary goal was investment, it is better to surrender the policy and invest in direct mutual funds or other comparably flexible investment options. Always conduct thorough research before making financial decisions to ensure you align your investments with your long-term financial goals.