Exiting ULIP and Lock in Period in ULIP Plans

United Linked Insurance Plans are a hybrid product that provides insurance coverage and investment opportunities through equity and debt funds in the capital market. A ULIP investment entitles you to a tax credit of up to 1.5 lakh per annum under section 80C and on maturity benefits under section 10 (10D) of the Income Tax Act of 1961. However, tax laws are subject to change from time to time. The IRDAI changed the guidelines relating to ULIPs in 2010 and extended the lock in period from 3 to 5 years. Suppose the investor surrenders his policy before the 5-year period ends. In that case, the discontinuance charges are deducted from the fund value, and the amount is transferred in the Discontinued Policy Fund. The remaining proceeds are given only after the lock in period ends.

What is the ULIP Lock-In Period?

In the event of an emergency or in times of necessity, ULIPs allow for partial withdrawals after the minimum lock-in period. You can make partial withdrawals as long as the total amount you remove in a year does not exceed 20% of the fund's value in a policy year. Partial withdrawals are completely free of charge. However, because ULIPs are intended for long-term purposes, try not to withdraw money unless absolutely essential. Lock-in period is the duration within which if you (the policyholder) surrender or discontinue the plan, you will not receive the stipulated payout. Basically, it is the duration in which the policyholder cannot withdraw or liquidate the accumulated fund value. Generally, the lock-in period for ULIPs is five years. After completion of the lock-in period, you will receive the necessary payout.

Why do many people exit from the ULIPs after the lock-in period ends?

Now that we know what is a ULIP lock-in period is, it's time to answer a simple question: Here are all the answers.

• The transparency of ULIPs is due to the fact that they allow you to pick the fund choice based on your risk appetite and follow your fund performance. If the fund is not doing well, an investor may choose to quit and utilise that capital elsewhere to achieve high returns.
• Many individuals buy ULIPs at the end of the year because they are a wonderful tax-saving option, but there are many other options, such as NPS and mutual funds with ELSS options, that may be purchased for tax savings and investing objectives.
• When there is a financial crisis, individuals may want funds for other uses.
• ULIP charges are front loaded and amortised over 5 years, so the fund may be performing well, but investors may not be able to see it due to various charges such as fund management, mortality charges, premium allocation, policy administration charge, and so on, so they may want to choose another investment option with fewer charges.
• ULIPs are long-term financial products that are not ideal for medium-term investing; customers may choose more liquid choices to ULIPs, which lock their money away for an extended period of time.
• ULIP features may not always fulfil their needs or correspond with their financial objectives.

But this is not recommended. It’s not a good idea to exit your ULIP plan as soon as your lock-in period ends, and here’s why.

Compounding Benefits Lost

ULIPs are long-term investments that provide the best profits only in the long run. ULIPs invest in a variety of funds, ranging from equities to debt. If you place your money into stocks, withdrawing it in such a short period of time will result in lower returns. The benefits of compounding will be negated if you withdraw too soon. In the case of compounding, the corpus develops at a quicker rate later in life. For the sake of clarity, suppose a base amount of Rs 1 lakh invested at an annual rate of 8%. In five years, the investment will earn Rs 10884 in annual interest, but in fifteen years, the annual interest would increase to Rs 23500. It is very evident that if you abandon a ULIP after only five years, you will forfeit the benefits of compounding.

Impact of Market Cycles

ULIPs invest in a wide range of funds, from equities to debt. Equity markets are renowned for being volatile in the short term, but they outperform other assets in the long run. Long-term investing considers market cycles as well. If you withdraw after five years, you may become caught in a market downturn and receive subpar results. Attempting to leave during a market bull run, on the other hand, will result in a significant loss of capital appreciation. Long-term investments smooth out market cycles' volatility and provide generally stable profits.

Front Loading

The front-loading of costs is another key reason for not leaving a ULIP after five years. The majority of the charges, such as premium allocation charges, fund allocation charges, fund management fees, and policy administration fees, are typically levied on ULIPs in the first year. Some of the costs are offset by cancelling units or modifying the funds' NAV (Net Asset Value).

The fees are hefty in the first year but gradually decrease. In the fifth year, the charges are essentially non-existent. Exiting a ULIP shortly after the lock-in period ends would mean passing up a possibility for significant capital development. Aside from the different expenses, leaving after five years would entail renouncing loyalty additions. The loyalty enhancements are paid simultaneously with the accrued fund when the ULIP matures. The impact of loyalty varies per insurer, but it can provide a significant boost to the corpus.

Summing Up

You may realise the rewards of long-term investment throughout the lock-in period. Even at this point, though, there are better options than relinquishing your coverage. If you have an urgent need for money, you can use the partial withdrawal option of ULIPs. It allows you to pay out a portion of your fund value rather than relinquishing your policy.

It is important to understand that ULIP is a long-term investment that only grows in later years when the influence of charges has worn off. Remember that you have paid a major share of total costs in the first five years, and an exit will be unnecessary when the time comes for fund value to increase.

If the fund is not doing well today, you should consider how it did during the bull era. It may take some time, but the fund will eventually perform well. You should never withdraw your money if it is less than what you deposited. Again, if you have a need for money, you can make a partial withdrawal. So, if you are seeking a long-term investment, you might consider purchasing a ULIP since there are often loyalty advantages for those who stay until the end.