ULIP #2 – understand the charges

What are the relevant charges that need to be understood when you are looking at ULIP as an investment option? Well, there are essentially 5 charges which you need to be cognisant about. Let us take a look at the charges and what they mean.

  1. Premium allocation charges : This charge is linked to distribution expenses and underwriting costs for the insurance. In the older ULIP these charges were very significant for two reasons. Firstly, these charges were quite high and secondly, the bulk of these charges were front loaded, to be deducted in the first year. So much so, that nearly 65 % of the first year premium. No wonder ULIP was hated by most investors when they found this out, especially since many of them were not clearly told this by agents who sold it to them.
  2. Policy administration charges: These are mainly for the documentation and other administrative charges linked with the insurance part of the ULIP.
  3. Mortality charges : These are also linked to the insurance of the investor.
  4. Fund management charges: This is similar to the Expense Ratio of Mutual Funds and deals with expenses related to investment related expenses.
  5. Surrender charges : Relevant only when you want to discontinue the ULIP.

The first of these charges are linked to how the ULIP is sold. In case you are buying it from an agent like a bank, expect it to be high, even though after IRDA has got into the act it has become way more reasonable compared to before. However, for many ULIP that you can buy online nowadays these charges are non existent. The other change is that even where the charges are there, front loading like in the past is not really there. This means, much of your money now actually goes into buying the units which is a sea change from the past.

The next 3 charges are in the form of cancelled units and is normally done monthly. IRDA has put caps on the charges and the Fund management charges can today be a maximum of 1.35%, a cost that is significantly lower than the Expense ratio of most MF. Now, IRDA has also stipulated as to how much your overall returns can come down due to all these charges. For example a 15 year ULIP, the overall reduction can be a maximum of 2.25% and this is 3% in case of a 10 year ULIP.

What do these changes realistically mean for you as an investor? Well, it opens up another investment possibility apart from the regular avenues you are already using. In the next post I will outline how you may be able to use ULIP effectively.

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