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How are Capital Gains Calculated on ULIPs?

When an individual is choosing financial instruments, one of the major factors they consider is their performance. The best investments would ideally be the ones that offer tax benefits along with good returns. So, more and more people are choosing instruments like Unit Linked Insurance Plan (ULIP) nowadays.

ULIPs are market-linked investment plans that are a combination of insurance and investment. The premiums paid are partly allocated towards providing life coverage and partly used towards the allocation of funds. The funds are usually invested in equity, debt, or balanced funds, depending on an individual’s financial objectives and risk appetite. One of the unique ULIP benefits is that you can switch this allocation anytime you want. Since they are market-related investments, the flexibility of switching the fund allocation allows an individual to maximize their returns. You can use a ULIP return calculator to get an estimate of your returns on your investments. Also, if one stays invested for the long haul, ULIPs can offer them exceptional returns with the power of compounding. Once you earn enough profits from your ULIP, it is important to know how capital gains are calculated on it.

Calculating capital gains on ULIP

The returns of ULIPs are usually determined by the investment assets, taking the ULIPs costs and market performance into consideration. One can choose from a variety of investment alternatives, be it equity funds like a large-cap, small-cap, mid-cap, or hybrid fund, or bonds that are safe funds or ultra-short funds. One can pick the asset allocation they want based on the financial goal of their ULIP. The goal will help an individual determine the type of investment they want to go for and the duration of the investment, too. Policyholders use tools like a ULIP return calculator to get an estimate of the returns on the funds they are planning to invest in. Usually, equity funds are high in risk and offer high returns, while debt funds are comparatively safer and offer low returns usually when compared to equity. Here are two ways one can calculate their ULIP returns:

  • Absolute returns
    You can determine the absolute returns of your ULIP simply by its Net Asset Value (NAV). The simple method to go about this is knowing the NAV of your ULIP when you purchased it and the current NAV.

The formula goes like this:

Absolute returns = [(Current NAV – Initial NAV) / Initial NAV] x 100

In the calculation of NAV, ULIP expenditures like fund management fees, premium allocation charges, operation charges, surrender charges, mortality charges, and administrative charges are deducted. These charges used to be hefty when ULIPs were launched. Fortunately, that has transformed over the years, with most companies offering nominal charges or no charges at all. If you are invested in ULIP for a short horizon, absolute returns are the best way to understand how your ULIP fund is performing. However, in the long haul, the strategy has some setbacks. The absolute returns involve the profits that you make on your initial investment. This method will be rendered useless if your initial investment itself changes. One of the ULIP benefits is compounding, where the initial investment is multiplied over the years. This is the reason that absolute returns are only appropriate when you want to measure the returns for the first few years.

  • Compound Annual Growth Rate (CAGR)
    Another effective method for calculating your ULIP earnings is CAGR. The approach is effective when one stays invested in it for the long haul. It is important to know your current NAV and your initial NAV for calculating the CAGR of your ULIP. Here is how you go about it:CAGR = {[(Current NAV/Initial NAV) ^ (1/number of years)]-1} * 100

    The lock-in period of ULIPs is 5 years. Most people stay invested in ULIPs for longer, to get higher returns. CAGR is a method that has been proven quite effective for determining the returns of ULIP for the long haul. Similar to annual returns, CAGR also has several drawbacks. Over the years, the method cannot consider the volatility of returns.

The above methods are suitable for evaluating the performance of your ULIP. In order to earn good returns from your plan, it is important to strategize your allocation between equity and debt effectively. Depending on your age, your dependents, and your earnings, your risk appetite will change over the years and so can your fund allocation. Most insurance companies allow policyholders to switch freely between the debt and equity funds of their ULIP. Since they are directly linked to the market, adjusting on the basis of the market is the best way to maximize your returns.

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