Thinking about an investment-linked policy (ILP) but unsure if it’s the right fit?
You’re not alone – ILPs can be confusing, and without the proper knowledge, you could pay more than you need to.
I’ve been through the ins and outs of ILPs, so in this post, I’ll break down exactly what you need to know before diving in.
Here’s what you’ll learn:
- What an investment-linked policy (ILP) really is and how it works
- The differences between traditional ILPs and investment-focused “101-wrappers”
- Key benefits, drawbacks, and common fees to watch out for
- How to decide if an ILP suits your financial goals and lifestyle
If you want a straightforward guide to understanding ILPs and whether they’re right for you, keep reading.
What is an investment-linked policy (ILP)?
An investment-linked policy (ILP) combines life insurance protection with the chance to grow your wealth through investments.
This means you’re getting insurance coverage and the potential for investment returns – something like a whole life plan, but with all or most of your premiums used for investments.
When you purchase an ILP, the premiums you pay don’t just sit around.
Instead, they’re invested in a selection of sub-funds, which are usually managed by financial professionals.
Let’s clarify something first…
There are 2 main types of ILPs: the one that many financial experts (and everyday folks) often advise against, and the one that’s more focused on pure investments.
The ILP that’s bad in everyone’s eyes (and potentially is)
This is what we call the traditional ILP, or insurance-based ILP.
This type of ILP allows you to control both the insurance and investment components of your policy.
On the surface, it sounds great, right?
But here’s the catch: these traditional ILPs often come with hefty fees and complex structures that can eat into your returns.
Many policyholders, after years of paying premiums, find that their returns don’t match up to the promises.
It’s easy to see why they get a bad reputation – they’re complicated, costly, and sometimes the fees can feel like they’re designed to benefit the insurer more than you.
I’ve covered my thoughts on this type of ILP in detail here.
The ILP that everyone thinks it’s bad (but might not exactly be)
This type of ILP is what we like to call the investment-based ILP, or sometimes, the “101 wrapper.”
Here, the primary focus is on growing your wealth, while the insurance component takes a backseat.
With investment-based ILPs, your insurance coverage typically amounts to 101% of the total premiums you’ve paid.
In other words, you get a minimal insurance payout – just a little extra above what you’ve invested.
The main appeal here is that almost everything you put in is allocated towards investments rather than insurance charges, giving your money more potential to grow over time.
These are the ILPs that I’ll talk about in today’s post.
How do investment-based ILPs work?
With an investment-based ILP, you can select the amount you want to invest and set a schedule that suits your financial situation – monthly, quarterly, biannually, or annually.
Typically, you’ll keep investing until the policy reaches its maturity date, 10, 20, or even 30 years later.
At maturity, you get the benefits of any growth your investments have made.
In many ways, an investment-based ILP functions similarly to a robo-advisor.
You put your money in, and it’s invested on your behalf in a mix of funds.
Of course, there are fees involved – management fees, fund charges, and sometimes even switching fees if you want to change your fund allocation.
But the goal is to keep your investments working for you and, ideally, to grow your wealth over time.
Reasons to buy investment ILPs
Get started with investing
One of the biggest appeals of investment-based ILPs is that they’re a beginner-friendly way to start investing.
You don’t need extensive market knowledge or spend hours analysing stocks.
Instead, your premiums are allocated into professionally managed sub-funds.
It’s a hands-off approach, making it ideal for those who want to invest but don’t have the time or expertise to manage individual investments.
Plus, you have the flexibility to choose from a variety of funds, whether you prefer a balanced approach or something more aggressive.
Access to accredited investor funds (certain policies)
In simple terms, these are exclusive, high-quality funds that usually require a higher level of income or net worth to access.
Through certain ILP policies, even regular investors can invest in these specialised funds, which are often managed by top-tier fund managers and have the potential for higher returns (though they also come with higher risks).
This can be a game-changer if you’re looking for diverse and high-growth investment options but wouldn’t otherwise qualify as an accredited investor.
Let someone else manage it for you
Instead of making daily investment decisions, you can leave it to experienced fund managers who handle the nitty-gritty details.
They’ll monitor the markets, adjust the portfolio, and make strategic decisions based on market conditions – all so you don’t have to.
It’s a “set it and forget it” approach, ideal for those who want exposure to investments without the stress of managing them.
Protection in case of death during a market downturn
Here’s a reassuring feature: if you were to pass away during a market downturn, your loved ones would still receive at least the total premiums you’ve paid.
This can be a comforting safeguard, especially when markets are volatile.
While the investment portion may fluctuate based on market conditions, most ILPs ensure that, at a minimum, your beneficiaries receive the premiums you contributed.
Things to note when investing via a 101-wrapper
Is this a 101-wrapper or a traditional ILP?
Before signing on the dotted line, know exactly what type of ILP you’re getting into.
There’s a big difference between a 101-wrapper and a traditional ILP, especially regarding fees, structure, and focus on investment versus insurance.
I find that most financial advisors don’t volunteer this information, so it’s crucial to ask directly.
If you’re unsure about the differences, check out my post on traditional ILPs here.
What are the overall compulsory fees?
Policy-level fees
These fees apply to the ILP policy, regardless of the specific funds you invest in.
Common policy-level fees include administration fees, which cover the general management of your policy and are typically charged monthly.
Additionally, there are insurance costs.
Even though a 101-wrapper focuses more on investment, there’s still a minimal insurance component, especially if your sum-at-risk hits below a certain amount.
You’ll see a charge for the basic life coverage of the ILP.
Portfolio-level fees
Portfolio-level fees are charged for the overall management of funds within your ILP if it invests in a portfolio instead of the funds directly.
These include management fees, which are annual charges based on a percentage of your portfolio’s total value.
Switching fees may also apply if you exceed the free fund switches allowed under your policy.
Additionally, account maintenance fees may be imposed if your ILP policy includes a separate account for investment purposes, covering the costs of managing that account.
I’m not a fan of ILPs that invest in a portfolio, which invests in a bunch of funds, when other 101 wrappers can invest directly into funds.
This adds an unnecessary layer of fees that will severely eat into your returns.
Sometimes, the portfolio may be an insurer sub-fund.
The insurer sub-fund invests in other funds, which again adds an unnecessary level of fees.
I would avoid if I see an policy that does this.
Fund-level fees
Each fund within your ILP may have fees, which can vary depending on the type of fund selected.
These include fund management fees, an annual charge by the fund manager expressed as a percentage of the fund’s value to cover the cost of managing and operating the fund.
Some funds also impose upfront sales charges, deducted from your initial investment.
Additionally, performance fees may apply if the fund exceeds a predetermined return threshold.
Lastly, redemption fees could be charged as a penalty if you choose to exit a fund early.
What funds are offered and how well are the funds performing?
ILPs offer a range of funds suited to different risk profiles.
This includes equity funds, bond funds, balanced funds, speciality and sector funds, and accredited investor funds.
Performance varies widely across different funds, so it’s essential to research before making a choice.
When evaluating fund performance, look at the historical returns, compare them to benchmarks, and assess risk-adjusted returns.
Consider the fund manager’s expertise and monitor expense ratios, as high fees can reduce net returns.
Additionally, low-cost funds with strong performance often offer better value.
Make sure you’re not investing in insurer sub-funds
When selecting funds within an investment-based ILP, it’s important to determine if they are insurer sub-funds or standard unit trusts.
Insurer sub-funds often carry additional fees that are not always reflected in the projected returns, potentially reducing your actual gains over time.
To avoid these extra costs, ask your agent, or talk to one of our financial advisors.
What’s the minimum investment period?
Investment-based ILPs usually come with a minimum investment period (MIP).
This is the length of time you must keep contributing to the policy before you can fully access or withdraw your investment without penalties.
This period can vary widely, typically from 5 to 20 years, depending on the specific policy.
Because of these minimum investment periods, you must be confident that you can commit to the policy for the full term.
Any premium holidays?
Yes, some investment-based ILPs come with the option of a premium holiday.
A premium holiday allows you to temporarily stop making premium payments without cancelling your policy, which can be particularly helpful during financially challenging times or unexpected life events.
Any premium waiver riders?
Yes, some investment-based ILPs offer premium waiver riders as an add-on, providing an extra layer of financial security.
It ensures that if you cannot continue paying premiums due to specific circumstances – such as critical illness or total and permanent disability – the policy remains active without requiring further premium payments.
If it’s possible, I think adding a premium waiver for early critical illness might just be crazy worth it.
Think about it, if you’re diagnosed with ECI, your policy premiums are waived and you continue to benefit from an ever-growing investment value until the minimum investment period is over.
Can I make top-ups?
Most investment-based ILPs allow you to make top-up contributions.
Top-ups are additional, optional payments directly into your investment, giving it a potential boost.
This flexibility can be helpful if you come into extra funds – like a bonus or an inheritance – and want to increase your investment without altering your regular premium schedule.
Can I make withdrawals?
Most investment-based ILPs allow you to make partial withdrawals, giving you access to your funds without fully surrendering your policy.
This feature can be beneficial if you need liquidity for unexpected expenses or specific financial goals.
While partial withdrawals offer flexibility, they can impact your long-term returns.
Each withdrawal reduces the invested amount, leading to a slower wealth accumulation if done frequently.
Additionally, some policies may charge withdrawal fees, so it’s wise to confirm any costs with your provider.
What’s your financial advisor’s track record in managing investments?
Before committing to an investment-based ILP, evaluate your financial advisor’s experience, transparency, and track record with similar investments.
Look for advisors with extensive ILP experience, relevant certifications, and a history of managing portfolios effectively.
They should provide tailored recommendations based on your financial goals, be transparent about fees and costs, and demonstrate a consistent track record of managing funds, even during market volatility.
But there are disadvantages to investment ILPs, too…
I’m not someone who publishes a post about a specific product only highlighting the good stuff – that’s not how I do things.
ILPs do have disadvantages, especially when compared to other investment options.
Minimum investment periods
Investment ILPs typically come with minimum investment periods (MIP), which lock you into contributing for a specified timeframe – often ranging from 5 to 20 years.
During this period, accessing or withdrawing your funds can incur penalties, which can be substantial in the earlier years.
You need financial stability and a long-term commitment to maximise the policy’s benefits.
If your financial situation changes, or if you need access to funds before the MIP ends, early withdrawals can significantly impact your returns, as penalties and charges will reduce your payout.
High fees
These fees can be layered at multiple levels – policy-level, portfolio-level, and fund-level – each of which can eat into your returns over time.
While these fees cover professional management and certain benefits, they can reduce the overall growth of your investment.
Some ILPs have fee structures that are not deducted from the illustrated returns, meaning the returns shown may not fully reflect what you’ll receive.
ILP sub-funds have an additional layer of fees that eat into your returns
A hidden cost in some investment-based ILPs is the additional layer of fees associated with insurer-specific sub-funds.
Unlike standard unit trusts, insurer sub-funds often carry fees directly to the insurance company.
These fees are often not deducted from the illustrated returns, meaning the projections you see might not account for the full impact on your net returns.
While these sub-funds may seem similar to public investment options, the extra fees can subtly but significantly reduce your overall gains over time.
To avoid this, consider whether the ILP offers direct access to unit trusts.
Who should get investment-based ILPs?
You’re not financially savvy
If you’re not confident in your financial knowledge or investing skills, an investment-based ILP can be a practical solution.
With ILPs, the funds are selected and managed by your financial advisors, so you don’t need to analyse markets or make decisions about asset allocation constantly.
This hands-off approach allows you to invest without a deep understanding of stocks, bonds, or other assets, as the fund managers handle these details for you.
Do not have the time to manage your own investments actively
If your schedule is packed or you don’t have the time to actively monitor and manage an investment portfolio, an investment-based ILP can be a smart choice.
With an ILP, your financial advisor takes on the responsibility of handling your investments, making strategic adjustments and monitoring market trends so you don’t have to.
This “set it and forget it” approach allows you to build wealth without dedicating hours to researching funds or tracking market performance.
You want your capital to be protected
With a 101 wrapper, your capital is protected, and it’s usually 101%.
So if you have $100,000 invested, you’ll get at least $101,000 back upon maturity, even if markets are in a bad state.
This is something that other investment platforms cannot offer and is unique to ILPs.
Conclusion
Investment-based ILPs can be a convenient way to grow your money while keeping some insurance coverage in place.
We’ve looked at how these policies work, from the flexibility of premium holidays and top-ups to the added fees and minimum investment periods to watch out for.
Yes, you can learn and manage your own investments, but that takes up significant time.
You can also take conventional advice and invest in the S&P 500 or adopt the 3-fund portfolio, but this is not for everyone, especially if you don’t understand what risk tolerance is and how to rebalance your portfolios.
Someone else might argue that robo advisors are a better alternative, but they offer generic portfolios not meant for everyone.
101 wrappers are helpful for those who aren’t keen on managing their investments actively or don’t have much financial expertise but still want a hands-off, personalised approach to building wealth.
I’m not saying ILPs are good, but I’m clarifying the negative aspects of ILPs due to many not fully understanding the differences between the various types.
Of course, every financial situation is unique, and an ILP might not be the right choice for everyone.
It’s essential to get a second opinion to ensure any policy you’re considering truly fits your goals.
If you’re still unsure, our unbiased financial advisor partners are here to help.
Reach out for a free consultation and ensure your choice aligns with your financial future.
