Life insurance plans having an investment component are broadly divided into two categories—traditional life insurance policies and unit-linked insurance plans (ULIPs). Both these types of plans are quite different from one another. So, before determining which one could be better for you, let’s understand what these plans are all about.
What Are Traditional Life Insurance Plans?
Traditional life insurance plans are those that usually pay a guaranteed benefit on maturity or death. The premiums that you pay are invested by the company as per the rules of the Insurance Act, 1938. Some plans also offer bonuses and/or guaranteed additions that enhance the plan benefits. Endowment assurance plans, and money-back plans are common examples of traditional life insurance policies.
What are ULIPs?
Contrary to traditional plans, ULIPs are market-linked insurance-cum-investment plans. The premiums that you pay are invested in market-linked funds of your choice. Each fund has a ULIP NAV based on which units are allocated. Depending on the market performance, the funds grow and you get returns on your investments. Under ULIP plans, the benefits are not guaranteed as they are linked to the capital market into which your premiums are invested.
Difference between Traditional Plans and ULIPs
Here are some of the major differences between traditional plans and ULIPs:
|Basis of difference||Traditional plans||ULIP plans|
|Nature of the plan||Guaranteed benefit plans not linked to the performance of the markets||Investment-oriented plans that are dependent on market performance|
|Returns||You can earn bonuses, guaranteed additions or loyalty additions depending on the plan selected||Returns depend on the market and are non-guaranteed. You can use the ULIP plan calculator to estimate the returns that you can earn|
|Transparency of investments||How the premium is being invested is not disclosed to the policyholder||How your premium is being invested, the charges and the returns are disclosed clearly.|
|Benefit payable||A specified benefit is paid on death or maturity||In the case of death, higher of the sum assured or the fund value is paid. In the case of maturity, the fund value is paid.|
|Flexibility||Not available||Features of partial withdrawals, switching, premium redirection, top-up, etc., are allowed|
|Policy loan||Available against the surrender value under most plans||Usually not available|
|Bonus||Offered under some plans||Not available|
|Lock-in period||1 to 3 years depending on the premium payment mode||5 years|
|Tax benefits||Premium paid is tax-deductible up to Rs. 1.5 lakh under Section 80C. The death benefit is always tax-free. Maturity benefit is tax-free under Section 10(10D) if the premium paid was up to 10% of the sum assured.||Premium paid is tax-deductible up to Rs.1.5 lakh under Section 80C. The death benefit is always tax-free. In the case of maturity benefits; however, if the aggregate premium across all ULIPs is up to Rs. 2.5 lakhs and the premium is up to 10% of the sum assured, the maturity benefit is tax-free. If, however, the premium exceeds Rs. 2.5 lakhs, the returns earned from the plan would attract equity or debt taxation depending on the ULIP fund into which you invested.|
Which One Is Better?
Now that you know the meaning of traditional plans and ULIPs as well as their differences, which do you think is better? When it comes to choosing between the two, both the plans have their respective pros and cons. While traditional plans give guaranteed returns, the returns might be limited when the market is rallying. Conversely, ULIPs can give attractive returns but they are prone to market risks too. So, the choice, ultimately, depends on your investment needs and risk profile.
You can choose traditional plans if:
- You are a risk-averse investor and want guaranteed returns
- You want to avoid market exposure
In contrast, ULIPs are favourable if:
- You have a healthy risk appetite
- Want to earn market-linked returns
- Want flexibility during the policy tenure
The Bottom Line
Assess your investment needs and risk profile and then choose between traditional plans or ULIPs as per your suitability. You can also choose both for a diversified portfolio and to get the best of both worlds. So, understand what these plans are all about and then make an informed decision about which to buy.