Monday, June 8, 2009

WHY INVESTING IN ULIPS JUST FOR TAX SAVING IS NOT A GOOD IDEA

ULIPS or Unit Linked Insurance Plans are quite popular in India as a tax saving instrument which offers the dual advantage of insurance cover and superior market returns. While it seems a good proposition in the beginning , a closer and detailed study will tell you that this may not be the best option for you if you are looking at this as just a tax saving investment.
ULIPs , in India, are primarily sold by insurance agents as a product with just 3 years lock in after which the policy holder need not pay any premium and the policy continues .They also wrongly pitch ULIP as a product where the policyholder can withdraw the money whenever he needs after 3 months. While this is true there are certain things which you the agent never tells you. While investing in a ULIP fund for 3 years , you hope to

1. Save income tax on your investment for 3 years.

2. Make some decent returns on your investment.

3. Withdraw after 3 years which will be good returns over your investment.

4. Or continue the plan without paying any premium and then withdraw the amount as and when required.

These are the premises on which an insurance agent sells you the plan. However, if you invest in ULIP only for 3 years ,other than saving income tax, none of the above mentioned goals will be fulfilled. The reason for this is explained in the following paragraph.
ULIPS are notorious for being the investment tool having a very high upfront cost structure. The insurance companies will charge anywhere between 20-50% of your first year premium in the name of charges. There are various heads under which these charges are shown like mortality charge,admin charge,policy maintenance charge etc. Now over a 3 year period you end up paying huge amount of money towards meeting these charges , as a result of which the net money which is invested in the fund is much lesser than what you paid as premium. For example , if you paid Rs 100000 as premium and the ULIP has even a moderate cost structure at 35% for first year , you will have only Rs 65000 invested on your behalf by the insurance company . So you loose Rs 35000 as charges alone.
Now lets examine the savings or gains out of this investment. Assuming that you are in the highest tax bracket (Rs 5lakhs and more annual income) and your entire Rs 100000 invested in Ulip qualifies for tax deduction , then at tax rate of 30% you will save Rs 30000. And then assuming that the money was invested in debt fund (since you are looking to withdraw in 3 years time , debt fund is the most likely investment) the returns would be about 7-8% at best. So you will get another Rs 5200 on your investment. So total gain would be RS 30000 + Rs 5200 = Rs 35200.So, overall you gain Rs 5200 only on your 1 lakh invested in ULIps for the first year. Now , if you were to consider only the return on your investment discounting the tax saved, you actually end up loosing your money. Similarly, after 3 years, when you remove your money you will have to pay penalty and most probably loose some more on withdrawal since ULIP is a long term product. You can do your maths,depending on the charges mentioned in the policy documents, but, my guess is you will have to be extremely lucky to make any money in real terms on your investment in ULIP, if you were to remove the money after 3 years.
As far as continuing the policy after 3 years without paying premium is concerned, you can do so but, the company will keep on deducting the mortality charge (the premium paid towards providing life cover ) from your fund value. As a result of this , the fund value will keep on going down and unless the growth/returns in the fund is much higher than the mortality charge, the fund value will keep coming down in absolute terms. So , while the life cover will continue even after you stop paying premium, its not like that the life cover you get is free . You are still paying for it from your fund value kept with the insurance company. Hence, stopping premiums after 3 years is not a very wise decision . The concept of premium holidays are there to help policyholders in times of occasional financial distress where the policy does not lapse in case the policyholder misses one odd premium unlike a traditional endowment plan which lapses the moment one defaults on premium payment.
Coming back to the question of investing for tax purpose and for short duration, my pick would be ELSS. The reason for that is that ELSS do not have that high cost structure unlike ULIPs. They also do not have very high exit charges and there are no mortality charges as well. For any insurance needs one should buy a pure term plan.Investing for tax saving requires little bit of research and thought behind it. Do not invest your money only to save tax. There are instruments available which save income tax while offering you decent returns as well.

2 comments:

  1. what would be the best investment for todays date,considering bank intrest rate is low.

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  2. Well, if you are looking at investment for tax saving purpose, then I would suggest that you invest in well diversified equity based ELSS like SBI MAgnum TAx gain. Otherwise , you can look at any well diversified , 5 star rated (morningstar) equity or hybrid funds.

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