How ULIP works?

ULIP is a unique product that offers dual benefits of life insurance and investment. Similar to any other life insurance product, you are required to pay premiums. However, the premiums here are utilized differently. A part of the premium you pay is used towards providing a life cover and the other half is invested in funds of your choice. During the entire duration of your policy, you get a life cover. Once the tenure of your ULIP is over, you receive a maturity amount that includes the funds you had invested along with the returns you earned on them.
A ULIP policy comprises basically two major components: life insurance and investment. It is easier to understand how the policy works by understanding these aspects of the plan separately.
Life insurance
The life insurance aspect of ULIP works similar to any other life insurance product and is simple to understand. On purchasing a ULIP policy, you get life insurance for a specific tenure. During that tenure, if you lose your life as a policyholder, the nominee mentioned in your ULIP will receive the death benefit. The death benefit is the sum assured or the fund value of your investment, whichever is higher. Life insurance leaves policyholders assured that in their absence, there is a financial backup for their loved ones to rely on. The sum assured that the policyholder receives is exempt from taxes under Section 10 (10D) of the Income Tax Act. It is essential that you use tools like a ULIP calculator to determine sufficient coverage for your family. The thumb rule usually is that it takes care of their financial needs over the years along with repaying any debts you may have.
Investment
The investment aspect of a ULIP policy has several aspects to it. Half of the premium of your plan is invested in the funds of your choice. There are several funds you can choose from. Based on your risk appetite, these funds can be divided into three broad categories: equity, debt, and balanced funds. If you invest in equity funds, your money is invested in equity-based products. They have high risks involved, and the risk is usually offered with high returns. An individual who is risk-averse can invest in debt funds. The returns are lower compared to equity funds, but so is the risk involved. For those who are looking for moderate returns and risks, there are balanced funds. In these funds, the money is invested in both equity and debt funds.
It is possible that once you have invested in the funds of your choice, you change your allocation over the years as your life flourishes. With changing financial goals and responsibilities, switch the asset allocation of your ULIP. You can move your allocation from debt to equity and vice versa anytime you want. Switching allocation allows you to get significant ULIP returns in 10 years while maintaining your risk appetite. Since ULIPs are designed for the long haul, this ability to switch funds over the years allows you to maximize your returns.
If you are investing in ULIP for a particular goal, you can use a ULIP calculator that will help you plan your investment accordingly. One of the remarkable features of ULIPs is that you can multiply your returns over the years via compounding. With compounding, you earn returns not only on the amount invested but also on the returns earned in previous years. Check ULIP returns in 10 years of the plan that you are considering buying. It gives you an estimate of the returns you can earn from it.
ULIP has a lock-in period of 5 years. This lock-in period allows you to invest in a disciplined manner and inculcates the habit of savings. After the lock-in period, you can avail of free partial withdrawals from the ULIP policy anytime you want. This feature comes in handy during emergencies when you need funds urgently. You can withdraw funds without having to dissolve any investments or pay any additional charges. Apart from these features, there are several tax benefits you get when you invest in a ULIP. The premiums that you pay for your ULIP are exempt from taxes. Also, the maturity amount that you receive is subjected to exemptions provided certain conditions are met.