When people think about life insurance, they always consider Unit-Linked Insurance Plans (ULIPs) and term insurance. ULIPs focus on combining investment with insurance, whereas term insurance ensures life cover.
However, failing to understand the intricacies of these two results in poor decision-making. Here, we discuss the five most common mistakes people make when deciding between ULIPs and term insurance, and how to avoid these pitfalls.
Confusing insurance with investment
A common mistake aspirational ULIP and term insurance buyers commit is failing to understand the core purpose and objectives of these plans. ULIPs, for example, offer dual benefits. Under this scheme, a part of your premium amount is invested in market-linked funds. The rest of the amount is invested towards life insurance.
Still, many treat ULIPs as pure investment products and overlook the insurance component associated with them.
In stark contrast, term insurance is a simple, straightforward concept. It offers easy and seamless life coverage at a low cost but no maturity or investment benefit. On your part, you should carefully consider the pros and cons related to both and then decide if you need long-term protection, investment-based growth or both.
Failure to understand premium costs, hidden charges
ULIPs generally come with a range of costs and associated charges including policy administration charges, fund management fees, premium allocation fees, and mortality charges. Such charges can eat into your initial investment and long-term returns if they are not considered carefully.
Term plans, on the other hand, are much more cost-efficient, even more so if your primary objective is to secure life cover for yourself. Hence, failing to understand these cost differences, processing fees, and related terms and conditions can negatively affect your finances in the long run.
Ignoring lock-in periods and liquidity
Generally, ULIPs come with a mandatory five-year lock-in period. During this period, partial withdrawals are not allowed or are restricted. Term insurance, on the other hand, provides instant life coverage with no lock-in period.
You need to carefully understand this difference between the two, as selecting a ULIP without taking into account your short-term liquidity needs can be a costly mistake. Therefore, your objective should be to keep yourself at ease financially and free from any lock-ins or waiting periods.
Failing to evaluate risk-taking potential
ULIPs focus and invest funds in equity, debt or hybrid funds. This means that the returns are tied to market performance. While this can easily offer growth opportunities, it comes with associated market risks.
Term insurance, on the other hand, is an investment tool that provides guaranteed benefits with no investment risk. Hence, selecting a ULIP plan without understanding your risk tolerance capacity can result in dissatisfaction, anxiety, and immense stress, especially during market corrections and economic downturns.
Targeting short-term goals and needs only
ULIPs are designed to provide you with long-term wealth, such as retirement, children’s education, and health protection in later years, all thanks to their investment component.
Term insurance, however, serves those individuals in the most efficient way who are seeking affordable life coverage protection for a pre-defined period of time, i.e., term. Therefore, using a ULIP for short-term goals might mean paying higher processing costs, associated charges, etc., for limited returns. This can defeat the primary purpose of selecting ULIPs as an investment tool.
Tax implications and future outlook
The Indian government introduced major tax reforms related to ULIPs. Starting April 1, 2026, ULIPs with annual premiums of more than ₹2.5 lakh will be taxed under the capital gains regime.
Thus, they are aligned with mutual fund taxation. No recent tax changes have been made regarding term insurance policies.
Therefore, selecting the most appropriate life insurance plan depends on your financial goals, aspirations, risk-taking capacity, and long-term insurance needs. Avoiding these common mistakes and errors will go a long way in helping you make a well-informed decision, whether that means protecting your wife and children with term insurance or combining wealth creation and boosting protection through ULIPs.
Disclaimer: This article is for informational purposes only and should not be considered financial advice. Please consult a certified financial advisor before making insurance or investment decisions.
