Ch. 8:What is Fund Switching in ULIP? Know Types of Funds

Market conditions can be very volatile and influence fund performance. The fund you choose may not be performing as well as you had anticipated or the market may not be conducive to invest in the fund you have originally chosen to invest in. In this case, ULIPs provide a switching option to move your money to another fund that may be more suitable at that time.

But how do you switch from one fund to another? Is there a fee for switching between funds? - Let’s find the answers to these questions in this article.

After deducting applicable charges from the money invested by you, the insurance company invests the premium collected into the fund of your choice from the various fund options on offer.

You choose a fund depending upon the market conditions, your risk appetite and your requirements with respect to returns. Funds can be classified into three categories:

• Equity funds
  The premium is invested in the equity market. This is a high risk, high return option, where customers take high risk, to benefit from the high return potential of investing in the equity market through a professional fund manager.
• Debt funds
  The premium you pay is partially or totally invested in debt instruments like government or corporate bonds. These instruments offer much lesser returns in the long run, and are considered to be safer and more stable in comparison to equity investments.
• Money-Market Funds
  A type of a debt instrument that invests money in short-term money market instruments like commercial papers, bank deposits, treasury bills, etc. These possess high liquidity and have the potential to offer good returns.
• Balanced funds
  The premium paid is invested in a mix of debt and the equity market instruments to help investors get the best of both worlds. Partial upside of equity investments and partial stability from investing in debt.

Fund switching is a feature offered under ULIPs that enables you to move the units you own from one fund to another within the same plan instantly. The units can be transferred partially or completely between the investment funds. Funds can be selected according to market conditions, your risk tolerance, and financial goals.

The main purpose of this feature is to help you to manoeuvre the funds at certain times - whether to maximise your returns or protect the capital.

Please note that your existing fund value will be ‘switched’. Any further premiums you pay will keep investing in the fund you had selected when purchasing the policy.

It is important to note that switching in ULIP is more seamless and tax efficient than moving between different categories of funds under Mutual Fund. Here’s how -

• Instant Switching
  You can simply login to the insurers website and switch funds with a couple of clicks. In the case of Mutual Funds, you need to redeem the funds, before you can switch the money to the new fund which takes around 2-3 days to process.
• Zero Tax implication
  In case of ULIPs, you can switch between funds without any redemption. So, unlike Mutual Funds, ULIPs do not attract any Capital Gains tax.

Evaluate your Risk Appetite
Before considering a fund switch, you must figure out the level of risk you can tolerate. You need to analyse your earnings, savings, etc. to gauge the same.

According to your needs, debt or equity funds can be chosen. You can go for equity if you are seeking higher returns and have a high-risk appetite. If you want to mitigate risk, a debt fund is a viable option.

Here’s an example to understand the point better -

Case 1 : Madhav is 25 years old, and he chooses to get ULIP. His annual premium is Rs 50,000. He is a well-settled individual and has fewer financial liabilities. He believes he can handle risks.

Case 2: Bharat is 40 years old, and he chooses to get ULIP. His annual premium is Rs 1,00,000. Bharat has two children. As a salaried employee, he doesn’t feel comfortable taking big risks.

Let's take a look at each of their fund selections -

It is important to take your long-term goals into consideration when switching funds. Your goals can be - your child’s wedding, spouse’s higher education, buying an apartment etc. You should invest in funds that will ensure the completion of these goals.

Equity funds are more volatile for short-term goals, but for long-term goals, they might be the ideal choice. When you're just getting started, you can consider investing in equity funds to grow your wealth. Then, you can gradually shift to debt funds as you get closer to your goal as they are less volatile. And, debt funds are quite stable with low risk.

For example, Dev bought a ULIP in 2015 with the goal of buying a plot and building a house in ten years. He invested his annual premium of Rs 50,000 in equity funds as he had a higher risk appetite. Since the stock market performed well, it gave favourable returns over the years and he successfully built his home in 2027. After achieving his goal, he switched to debt funds because he wanted to minimise his risk and protect his remaining savings.

Individuals at different life stages have different priorities. Young people with fewer liabilities can afford to take more risks. This makes equity funds an ideal investment option for younger people. Your risk tolerance tends to decrease as you get older. For this reason, as you grow older, debt funds may be a better choice.

For example, Raghav bought ULIP in 2007 when he was 25 years old. He chose to invest his annual premium of Rs 1,00,000 in equity funds since he had to grow his wealth for his family. Upon turning 40 in 2022, he planned to switch from equity to debt funds owing to his financial responsibilities, debts etc. He chose to switch to debt funds as they are relatively stable, thereby reducing risk.

Depending on the product you purchase, the number of switches allowed can differ.

• Some products may allow you to make a limited number of switches, for example, one, three, five, or ten times in a policy year
• Some products may allow an unlimited number of switches in a policy year.

For example, Divya buys a ULIP and the premium is Rs 1,00,000. She asks her insurer to invest her money in Fund A, which entails a low level of risk. She is allowed to switch no more than three times under the policy.

Switch 1: Fund A to Fund B
After a few months, she decides to change to Fund B since it offers higher returns.

Switch 2: Fund B to Fund A
A few months later, due to her financial obligations, she decides to switch to fund A to minimise the risk.

Switch 3: Fund A to Fund B
Having cleared her financial liabilities, she decides to grow her savings and hence decides to switch back to Fund B.

Divya has reached her switching limits, as stated in her policy. She won't be able to switch further or she might be charged for the same.

Yes, depending on the product you purchase, you may need to pay a Fund Switching Charge when you switch the fund your money has been invested in.

The insurance company may allow a limited number of fund switches without imposing a charge. After a certain number of free switches, they may charge a fee for every fund switch.

The Fund Switching Charge is nominal and may range anywhere from Rs. 50 to Rs. 500. Charges may be deducted upfront from the fund value or by removing units proportionately from each fund that you have selected.

Payal purchases a ULIP for a policy duration of 20 years. Her annual premium for the plan is Rs 1,00,000. She chooses to invest in Fund A, which is an equity fund and hence, has the potential to give her high returns.

After a few years, she notices that the fund is not aligned with her financial goals

Her Fund Value under Fund A
Assuming that the Net Asset Value of the units was Rs 500 on the date of policy purchase and that Rs 5000 has been deducted as charges -

Total units = (Amount invested - Charges)/Net Asset Value
= (1,00,000 - 5000)/500
= 95000/500
= 190 units.

After a few years, the NAV reduces to Rs 300. So, she decides to switch her fund. Let’s assume that she accumulates a total of 500 units till then.

Fund Value of Fund A = Total owned units x NAV
= 500 x 300
= Rs 1,50,000

Now, she decides to switch from Fund A to Fund B, an equity fund that is performing well. So -

The fund value, i.e., Rs 1.5 Lakhs will be shifted to Fund B. Let’s assume that the NAV of Fund B is Rs 500 and that Rs 100 will be deducted as fund switching charges. So, the number of units she owns = (Fund Value of Fund A - Switching Charges)/NAV of Fund B

= (1,50,000 - 100)/500
= 299.8

Please note that the future investments will keep accumulating in Fund A, and not Fund B.

Fund switching is a useful feature, especially when you feel your current investment is not delivering the returns you expected. The number of switches and the fund switching charges may depend on the product. It is imperative that you discuss every detail related to fund switching beforehand with your insurer or your financial advisor - so as to avoid unpleasant surprises later.

And while fund switching is a great way to maximise your ROI, you also must be wondering whether it’s possible to use any of the accumulated funds before the policy matures. Read our article on how you can withdraw funds to know more!