One big advantage that ULIPs have over equity mutual funds is that the maturity proceeds from ULIPs are exempt from tax. On the other hand, the long-term capital gains on the sale of equity mutual funds are taxed at 10%. LTCG on sale of debt mutual funds is taxed at 20% after indexation.
In an earlier post, I highlighted why I still prefer mutual funds over ULIPs. I don’t deny I have biases.
If you still want to go for a ULIP, it is better to go with a low-cost ULIP. I highlighted the benefits of a low-cost ULIP (as compared to an expensive one) in this post.
In this post, I will discuss why you should never invest in a ULIP if you are old. Not even in a low cost ULIP. And this analysis is not biased.
Let’s understand the reasons. Let’s pick up a low-cost ULIP for the analysis (say HDFC Click 2 Invest).
As you can see, in HDFC Click 2 Invest, the Sum Assured will be 7 times annual premium if the entry age is greater than 55. Now, this is a problem.
Maturity proceeds of a life insurance plan are exempt from income tax only if the Sum Assured is at least 10 times the annual premium. With this condition, the maturity proceeds from the HDFC ULIP will not be exempt from tax if the entry age is greater than 55.
Therefore, in this case, the biggest advantage of ULIPs over equity mutual funds (tax free maturity proceeds) has been wiped out. Not just that, in the case of equity MFs, you pay tax at 10% of the capital gains. In the case of ULIP, the entire maturity proceed will be taxed at your slab rate (perhaps with adjustment for the premiums paid).
Why the insurance company kept the Sum Assured low?
This is one question that will come to any investor’s mind. The insurance company could have kept the Sum Assured at 10 times annual premium and continued to get the tax advantage.
Well, there is the problem of mortality charge.
Mortality charge in a ULIP is the amount that goes towards providing you life cover. Every ULIP has a mortality table. Mortality charge is charged on a monthly basis. Your fund units are liquidated to recover such charges.
However, the mortality charge is not charged on the entire Sum Assured. It is charged on the Sum-at-risk.
- In case of Type-I ULIPs, Sum-at-risk = Sum Assured – Fund Value. This is because this is the amount that the insurance company has to pay from its pocket in the event of the death of the investor. If the fund value exceeds Sum Assured, mortality charge for your policy will be zero.
- In case of Type-II ULIPs, Sum-at-risk = Sum Assured. Because that is what the insurance company has to pay from its pocket in the event of the death of the policyholder.
Clearly, everything else being same, you will pay more in terms of mortality charges in case of Type II ULIPs. For more on the two types of ULIPs, please refer to this post.
For old people, incurring mortality charges can be an unnecessary burden because:
- If you are closer to 60 or retired, you may not need life cover at all.
- The mortality charges increase with age. At an advanced age, the outgo in the form of mortality charges will be higher as compared to that for a 30 year old.
- The underwriting in ULIPs is a bit relaxed. Therefore, the cost of life cover can be quite high.
Here is the snapshot of the mortality table for HDFC Click 2 Invest. These charges are per Rs 1,000 of Sum-at-risk.
If the Sum Assured is the same in both the cases (say Rs 10 lacs) and if we assume that mortality cost is charged on an annual basis at the beginning of the year, the younger investor will mortality charge of Rs 0.9840*Rs 10 lac/ 1,000 = Rs 984 in the first year.
On the other hand, the older investor will incur a mortality charge of 7.8880 * Rs 10 lacs/1,000 = Rs 7,888 in the first year. This high difference will continue in the future too.
Everything else being same (fund returns, other charges etc), higher mortality charge means lower returns from the ULIP. I have discussed this aspect in an earlier post too. Your age affects your returns in ULIPs and traditional plans.
In one of the most egregious examples of mis-selling, a senior citizen invested Rs 3.2 lacs over 6 years in a ULIP and ended up with Rs 11,678. By the way, this post is not about mis-selling. It is more about the flaws/issues with a product structure.
By offering a low Sum Insured in ULIP, the insurance company tries to
Lower the impact of mortality charges for the older investors. The insurer is quite right in:
- Offering Type-I ULIPs to older people. This is because the Sum-at-risk goes down with the increase in Fund Value. This helps reduce the impact of mortality charges. Outgo towards mortality charges may go to zero once the Fund Value exceeds the Sum Assured.
- In offering a lower Sum Assured. Lower the Sum Assured, lower the Sum-at-risk, lower the impact of mortality charges.
Just that the tax laws require Sum Assured to be 10 times annual premium for 10 times (to make maturity proceeds exempt from tax). You can’t fault insurance companies for that.
If you are an old investor, avoid ULIPs
If you are young, I can’t fault you for purchasing a low-cost ULIPs provided you need life cover and the mortality charges are not very high. ULIPs are quite easy to understand for new investors. There are many issues with ULIPs, but I can live with that if you are buying at a young age.
However, if you are old, it is better to avoid ULIPs because:
- You will have to pay for life cover you do not need.
- The cost of that life cover (mortality charges) can be quite high at your age.
- The maturity proceeds will most likely be taxable.
By the way, single premium ULIPs will also face a similar problem. In case of single premium ULIPs, the Sum Assured (in HDFC Click 2 Invest) is only 1.25 times annual premium. The Sum Assured is kept low to reduce the impact of mortality charges. However, the problem is that the maturity proceeds will be taxable.
At the time of purchase, you may not be apprised of these issues. Typically, the salespeople focus only on the good parts. However, ignorance can’t be an excuse.
Be aware. Be informed.