ULIP vs Mutual Fund -Which one should you opt for?

ULIP or Unit Linked Insurance Plan is a financial instrument which is a fusion of insurance and investment. Therefore, if you are a ULIP holder, you are going to enjoy the benefits of both insurance and investment at the same time.

Being a ULIP holder, you are required to pay a regular premium for the insurance part. A part of such premium paid by you would get invested in financial instruments (combination of debt and equity) as per your choice of weightage. It is solely your discretion what your investment is going to be consisted of. Your choice is should match with your risk appetite, liquidity requirement, and financial goal.

On the other hand, a Mutual Fund is purely an investment product. The AMC or Asset Management Company pools the money from the investors (also called unit holders) for investing in financial instruments like shares, derivatives, and bonds. Such investments are professionally managed by the AMC through its experienced and knowledgeable fund managers. (Read more about Mutual Funds here.)

After the re-introduction of long-term capital gain (LTCG) tax on equity and equity oriented Mutual Funds in the Union Budget of 2018, people in India have started to discuss whether ULIPs have become more rewarding than Mutual Funds. In fact, many experts have stated that ULIPs have become more profitable than equity oriented Mutual Funds after LTCG tax has come into effect. ULIPs are not subjected to any capital gains tax.

However, it has to be stated here that taxation is not the only parameter that you should consider for selecting an investment product. There are many other key factors which you should keep in mind before selecting any investment product.

ULIP vs Mutual Fund

Here are some parameters that you should consider before selecting one investment product between Mutual Fund and ULIP.

What is your purpose of investing?

Before getting started, you should clearly define your purpose for investing. Having no clarity in purpose or creating vague goals in mind would never help you meet your financial needs in the future.

Suppose, you have set a goal to accumulate Rs. 2 crores in 30 years, you should go for investing. If your objective is to have your life insured, you should think of going for a term insurance plan.

ULIP is not a financial product which can provide you with an adequate insurance cover. If you already have got an insurance policy in your name, then you can consider investing in ULIP additionally. ULIP has an insurance element in it which Mutual Fund lacks.

In short, a ULIP plan is a combo of insurance and investment product at the same time. The premium that you pay on your ULIP plan, a part of the same is meant for providing you with an insurance cover. The rest of your payment is invested in a combo of debt and equity which is as per your discretion.

Further, it is a fact that a mutual fund does not offer any insurance component. But if you’ve planned properly, it is may not be a huge issue. You can start a mutual fund SIP and simultaneously take a term insurance plan alongside. It is going to help you artificially create a ULIP for yourself.

Who is more transparent between Mutual Fund and ULIP?

The disclosures of the underlying portfolio of a ULIP are not as transparent as that of a Mutual Fund because it is not mandatory for the ULIPs to disclose their NAVs on an everyday basis. In addition to that, the exact break-up of load on a ULIP plan is not available, unlike a Mutual Fund scheme.

Apart from the loading, expense ratio which in regard to a Mutual Fund plan is also mandatorily required to be stated clearly in the mutual fund fact sheet.

The Mutual Fund industry in India definitely comes in the list of the most regulated and transparent industries across the globe. From returns to underlying portfolios to sector allocation of investments, one can clearly find all the information in the online platform of an AMC and various other websites.

Furthermore, many analysts track Mutual Funds and publish their analysis time to time. It is not that ULIPs don’t disclose the information on analysis. But, they are not tracked by the analysts in a detailed manner like Mutual Funds.

Which is more tax efficient? ULIP or Mutual Fund?

If you invest in a ULIP plan, the premium that you will pay is eligible for tax deduction u/s 80C of the Income Tax Act, 1961 up to Rs.1.50 lakhs.

However, you won’t be getting this benefit if you invest lump sum or SIP in any equity or debt fund. Only if you invest (whether lump sum or SIP) in an ELSS Mutual Fund (an equity fund), then you can avail the income tax benefit under the said section.

Again, the capital gain from redeeming your investment in ULIP is fully tax-free in your hands, irrespective of whether the investment is in the nature of equity or debt.

However, this is to be noted that you are required to pay 15.6% effective tax on short-term capital gains in case of Mutual Fund redemption. And also, 10.6% tax has been introduced on long-term capital gains with effect from April 1, 2018, from equity mutual funds, in case the aggregate gains cross Rs.1 lakh.

Taxation rate on short-term gains from the redemption of debt funds is per one’s income tax slab, while the long-term capital gains are subject to tax @20% (excluding Cess) after indexation. From the angle of taxability, ULIP definitely seems to be a better choice, provided it yields higher after-tax returns than Mutual Fund.

Note: If you want to learn more about taxation of ULIPs, you can read this article. For studying more on taxation of Mutual Funds, you check out this post.

ULIP vs Mutual fund Comparison on the basis of costs.

If you decide to invest in a ULIP through online mode, you would save incurring significant expenses which are not only limited to administrative expenses and fund allocation charges. On the other hand, the expense ratios of Mutual Fund schemes are a little high, especially for the active funds. Furthermore, you can reduce the expense ratios if you invest in the direct plans.

Both these financial products have their own pros and cons. But, it can still be said that if you compare Direct Mutual Funds with ULIP, the former seems more cost effective.

Mutual Funds are more liquid than ULIP.

One of the most important parameters to look into any investment product is its liquidity.

An investment option should be preferred if you are able to liquidate your investments when you are in need of doing so. Mutual Funds are highly liquid in nature. You can redeem your units at any time and would get the proceeds straight into your bank account at most by 3days.

But, you can’t withdraw your investments from ULIPs unless the minimum lock-in period of 5 years gets over.

For mutual funds, it is only the tax saving ELSS funds where your investments get locked-in for 3 years. Rest other funds can be bought/sold/increased/decreased at any time. But, in case of ULIPs, the lock-in periods is an additional two years compared to even tax saving ELSS’s locking period.

Even after the lock-in period of ULIP ends, if you redeem your investments, it will around a week for your money to get credited in your bank account.

In terms of profitability, who is the winner?

In the case of ULIPS, a significant portion of your premium is actually spent towards costs, in the initial five years. The same gradually gets lower over time. So, even in an excellent bullish market, it will take you around half a decade to break even. Hence, if you look to earn returns which would beat the market in the long run, you require staying invested in ULIPs for at least one to decades.

However, the financial situation is not so complicated in the case of Mutual Funds. Many active mutual funds continuously beat the market and give superior returns to their shareholders since their origin. Furthermore, if you are investing in equity funds via the SIP route, you also be gaining the advantages of rupee cost averaging.

Note: To know more about profitability, check out this blog by Economic Times.

Flexibility – Do you know Mutual Funds offer more flexibility than ULIPs?

Investing in Mutual funds is of more flexibility than ULIPs. You can make a move from one scheme to another within the same fund house or another one. But, ULIPs allow you only to switch your investments from equity to debt or debt to equity but only within the same insurance house.

So, if the fund manager of your ULIP plan is underperforming or resigns from the company, it is going to be a matter of concern for you. You simply cannot move in such an adverse situation to a new insurance company without redeeming your existing investments before the end of its maturity period. A similar situation does not arise in the case of a Mutual Fund.

Summary

In this post, we have tried to highlight the features of Mutual Fund and ULIP. We have tried to draw a line by line comparison between these two investment products to help you understand how they both work in real.

Now, let us quickly summarize what we have discussed in this article.

• ULIP neither gives an adequate life cover nor offers a great investment opportunity.
• A Mutual Fund plus a Term Insurance Plan can comfortably compensate a ULIP.
• Mutual Funds are more transparent than ULIPs and also provide more comprehensive disclosures.
• ULIP is more tax efficient than Mutual Fund, given the former’s after-tax returns are higher.
• Both Mutual Funds and ULIPS investing are associated with several charges.
• Mutual Funds are more liquid, profitable and flexible than ULIPs.

From the above summary, it is clearly understood that the Mutual Fund seems to be a better financial product as compared to ULIP.

Generally speaking, the concept of combining insurance and mutual funds into one specific product is against the essence of financial planning. Financial planning means you will buy term policies for covering life risk followed by SIPs on equity funds to grow long-term wealth. ULIPs combine insurance and investment into one financial product thereby making ULIPs prone to mis-selling. This is because it is highly probable that many investors would fail to understand where insurance actually begins and where investing ends.

Anyways, ULIPs have always been more tax friendly as compared to Mutual Funds. On top of that, the introduction of income tax @ 10% on LTCG tax from equity investments, by the Union Budget 2018 has given ULIP more boosts. But, as discussed, you don’t choose an investment product on the basis of one parameter, do you? Mutual Funds do outweigh ULIPs on several grounds like profitability, transparency, flexibility, and liquidity.

Anyways, if you are sloping towards ULIPs, let us first discuss when you should consider opting for ULIPs.

• Do you want to have a life insurance cover which comes with an investment opportunity? Are you comfortable with moderate returns? If both of your answers are a yes, then ULIP is suitable for you.
• Further, can opt for ULIPs if your risk appetite is low or on the medium side.
• Apart from that, if you are looking for a tax saving financial instrument where liquidity is not of much importance to you, then also ULIP would not be an appropriate choice.

Now, let us discuss when you should give a thought to start Mutual Fund Investing.

• In case you have a risk appetite of a medium or higher side, then Mutual Fund is going to suit you.
• In case you are seeking a pure investment product with high returns, then Mutual Fund is the answer.
• And finally, if you are okay with paying a little additional tax on capital gains, but you want your investment to be liquid (Except ELSS), then you can go for Mutual Funds.

That’s all. We hope this article of ours will add to your knowledge and enable you to take a more rational decision with respect to your investments in the future. Happy investing!