In the last column, we addressed some of the myths surrounding Unit Linked Insurance Plans (ULIPs) and also reviewed a case where a ULIP might have been a more appropriate product given the temperament of the investor. Compulsive spenders are another category who could benefit from investing in a ULIP rather than a more liquid product that they can easily redeem and squander the proceeds.
A more recent case I remember is that of a young couple, both well employed in the IT sector and earning handsomely, but somehow perpetually facing a liquidity crunch whenever a payment commitment became due. This forced them to keep redeeming their mutual fund investments at frequent intervals, thus robbing their portfolio of the crucial compounding element that boosts returns.
Clearly, their problem was not one on the supply side as they earned well and their cash inflows were pretty impressive. Their problem area was their inability to control cash outflows, especially avoidable capital commitments like costly club memberships that they never ended up using more than a couple of times.
However, their opting for not just such a capital commitment but also ‘easy’ EMI installments to pay it further compounded their problems as the interest rates levied on them were abnormally high. Ever since they shifted to a ULIP a few years ago, there has been a cap on their expenses as it is not quite as readily redeemable as a mutual fund. In such cases, the limited liquidity for the first few years actually works as an advantage for compulsive spenders.
A unique feature of a ULIP is the flexibility it offers an investor to switch between equity and debt, depending on market conditions without incurring any tax liability on the switch in and switch out. With a well qualified advisor whose asset allocation skills are superior, this product can be used optimally to enhance returns or protection, depending on the objective. Alongside, a ULIP also offers a Life Cover benefit which can be flexed if one wishes, on reaching different life-cycle stage milestones. Another deal sweetener is that ULIP premiums are eligible for a tax deduction under Section 80C. Furthermore, the returns received on maturity are exempt from income tax under Section 10 (10D) of the Income Tax Act. These are dual tax benefits that ULIPs offer.
As in case of a mutual fund investment, so also in the case of a ULIP, the objective should be to stay invested over a long time horizon and not the minimum mandatory five year lock-in period. With the right allocation mix based on a long term goal or objective, the returns over a 10 to 12 year period can quite
often be better than anticipated. This is primarily because longer term tenures give enough time for the ULIP’s front loaded costs to be absorbed, and for the power of compounding to kick in.
Finally, and I cite this from having seen investor behavior at close quarters, ULIPs usually inculcate a forced sense of discipline into those investors who are best suited for this product. More importantly, it ensures that they do not barter their long term goals and objectives to fulfill their near term needs and desires. And that to my mind, is the deal clincher.
(The writer is head of LKW-India. He can be reached at email@example.com)