ULIP and Mutual Funds

While ULIPs and mutual funds have similar working principles, they are quite different from one another. let’s understand what ULIPs and mutual funds are and their respective benefits.

 

What is ULIP?

 

Short form for Unit Linked Insurance Plans, ULIPs are investment-oriented life insurance plans. The premiums paid under the plan are invested in funds that you choose. Each fund has a diversified portfolio of securities like equity, debt, gold, etc. You can choose one or more funds and the premium, net of applicable charges, is invested in the chosen fund. Thereafter, as the market performs, the underlying securities in the chosen funds grow or reduce in value. Thus, based on market movements, your fund value grows or falls.

ULIPs offer a death benefit if the life assured passes away during the policy tenure. On the other hand, if the life assured survives the policy tenure, the fund value is paid as the maturity benefit.

 

Advantages of ULIP

 

Some advantages of ULIPs are as follows –

1. Insurance coverage

   Being a life insurance policy, ULIPs provide financial coverage against the risk of premature demise. if the life assured passes away during the policy tenure, a death benefit is paid which can help the family deal with the financial loss suffered. Moreover, if the life assured had unfulfilled financial goals or an existing debt, the death benefit can be used to fulfil the goal or pay off the debt. Thus, besides investments, ULIPs also provide financial security to the life assured that in his absence, the plan would help the family face financial loss.

2. Market-linked returns

   With ULIPs, you can participate in the market and earn market-linked returns on your investments. If the markets are performing well, your investments can grow considerably and give you a good corpus for your financial goals. Moreover, if you choose a long-term tenure, the market-linked returns can grow your corpus considerably with the benefit of compounding.

3. Professional fund management

   The fund options available under ULIPs are managed professionally by expert fund managers. They pick the securities that comprise the fund portfolio. Moreover, they buy and sell securities to ensure that the portfolio performs well and delivers good returns while minimising investment risks.

4. Flexibility

   ULIPs offer a high degree of flexibility so that you can customise the plan per your needs and also have complete control over your investments. Some of the flexible features under ULIPs are as follows –

   • Choice of plan details –

     You can choose the premium that you want to invest (subject to the minimum and maximum limits prescribed), the premium payment term and frequency, the sum assured (if a choice of sum assured multiple is provided), the funds to invest in, the policy tenure and the riders to add to the policy.

   • Switching –

     ULIPs give you the freedom to change the investment funds if your investment strategy changes. This is called switching and the facility is allowed under all ULIPs. With switching, you can change the funds to limit your losses or increase your gains. For instance, if the equity market turns volatile, you can switch your equity funds to debt funds to protect your investments from volatility.

   • Partial withdrawals –

     Partial withdrawals allow you to withdraw from the fund value during the policy tenure. ULIPs have a lock-in period of 5 years after which you can make partial withdrawals for your financial needs and get easy liquidity.

   • Premium redirection –

     Premium redirection means changing the future premium allocation to another fund. You can opt for the redirection feature to invest your premium in other funds offered by the ULIP.

   • Top-up premiums –

     Top-ups allow you to invest more in the ULIP if you want to boost your investments. Depending on the ULIP selected, you can pay top-up premiums and boost the fund value to create a higher corpus for your financial goals.

5. Tax Benefits

   To add the cherry to the cake, ULIPs are highly tax-efficient. Here’s how –

   a. The premium paid for the policy qualifies as a deduction under Section 80C of the Income Tax Act of 1961 under old regime subject to conditions stated therein. The maximum deduction allowed is Rs.1.5 lakhs. To claim the deduction, the maximum allowed premium is defined as follows –

   i. 20% of the capital sum assured for policies issued on or before 31st March 2012¹

   ii. 10% of the sum assured for policies issued on or after 1st April 2012¹

   iii. 15% of the capital sum assured for policies issued on or after 1st April 2013 if the life assured suffers from a disease or disability defined under Sections 80U or 80DDB, respectively¹.

   b. The death benefit received is always tax-free².

   c. The maturity benefit received from ULIPs is also tax-free under Section 10(10D) if the premium is up to 10%, 15% or 20% of the sum assured depending on when the policy was issued³.

   d. However, for policies issued on or after 1st February 2021, the maturity benefit will be tax-free under Section 10(10D) if the aggregate annual premium paid for all ULIPs is up to Rs.2.5 lakhs³.

   e. Switching and partial withdrawals are also tax-free^{4 and 5}.

What are Mutual funds?

 

Mutual funds are pooled investment avenues which collect investments from different investors and pool the investment into a corpus. The corpus is, then, allocated to different types of market-linked securities depending on the investment objective of the fund.

There are different types of mutual funds and you can choose a fund which suits your financial needs, investment strategy and risk appetite. You can invest in mutual funds through a lump sum or in instalments via SIPs (Systematic Investment Plans).

 

• Advantages of Mutual funds:

  Some of the advantages of mutual funds are as follows –

• Market-linked returns

  Mutual funds are market-linked avenues which invest in a variety of securities like equity, debt, arbitrage, gold, indices, etc. With mutual funds you can get market-linked returns which can help you grow a good corpus for your goals.

• Professional fund management

  Mutual funds are managed by expert fund managers who manage the portfolio to enhance its return potential while reducing the investment risks. So, with mutual funds you can get the benefit of professional fund management.

• Easy liquidity

  Other than some mutual funds (Equity Linked Saving Schemes, Fixed Maturity Plans in debt funds close-ended funds, etc.)6, there’s no lock-in period. You can redeem your investment any time and convert it into liquid cash. This comes in handy for meeting financial emergencies.

• Affordable investments

  Mutual funds are pocket-friendly investment avenues wherein you can start a Systematic Investment Plan (SIP) with as little as Rs.100 per month⁷. Thus, mutual funds are suitable for small investors too who have a limited saving at their disposal.

• Tax benefits

  If you choose the ELSS scheme of mutual funds, you can claim a tax deduction under Section 80C of Income tax Act 1961, under old regime, subject to provisions stated therein, up to Rs.1.5 lakhs on the invested amount. This helps you reduce your tax liability. Moreover, long-term gains from equity are tax-free up to Rs.1 lakh a year.

   

  Differences between ULIP & Mutual funds

   

  Some of the common differences between ULIPs and mutual funds are as follows –

  1.  Insurance coverage

     ULIPs offer insurance coverage inbuilt under the plan. If the life assured passes away during the policy tenure, a death benefit is paid. no death benefit is paid under mutual fund if the life assured passes away.

  2. Lock-in period

     ULIPs have a lock-in period of 5 years. During this period, you cannot surrender the policy. Even if you do, the surrender value will be paid after the lock-in period is over. Partial withdrawals are also not allowed during the lock-in period.

     Barring a few, mutual funds have no lock-in period. You can sell them at your discretion and convert your investment into liquid cash.

  3. Loyalty additions or fund boosters

     Under some ULIPs there might be additional returns in the form of loyalty additions, wealth boosters or fund boosters. These additional benefits are usually declared at a fixed rate and help enhance the fund value. The returns from ULIPS depend on the market performance of the underlying fund.

     Mutual funds usually don’t have any loyalty additions or fund boosters. The returns depend on the market performance.

  4. Investment tenure

     ULIP plans come with a policy tenure. This tenure can start from 5 years and run lifelong (99 or 100 years under whole life ULIPs). Besides the lock-in period under some, mutual funds have no such tenure. You can stay invested for as long as you want.

  5. Switching

     ULIPs allow switching which helps you change between investment funds. This switching does not affect the policy and is also tax-free. There’s no concept of switching in mutual funds. If you want to change funds, you will have to sell or redeem the existing fund and then invest in another fund. This might attract applicable tax implications on the profits made from redeeming a fund.

  6. Partial withdrawals

     ULIPs allow partial withdrawals which help you draw from the fund value for your financial needs. Such withdrawals are tax-free. There’s no facility of partial withdrawals under mutual funds. If you withdraw from a fund, it will be treated at redemption which might be subject to tax implication too.

  7. Tax implication

     ULIPs offer tax benefits under Section 80C of the Income Tax Act, 1961, subject to the terms and conditions stated therein. The death benefit is tax-free and the maturity benefit also enjoys tax exemption if the ULIP was purchased before February 1, 2021. However, ULIPs purchased on or after February 1, 2021, will have a different set of ULIP maturity taxability rules, as specified under the Income Tax Act, 1961.

     In case of mutual funds, ELSS offers tax benefits under Section 80C. The returns earned from mutual funds, including any dividend, might attract taxation depending on your investment tenure and the type of fund that you have invested in.

   

  ULIP and Mutual Funds: Comparison between the two

   

  Besides the differences between ULIPs and mutual funds stated above, here’s a comparison table between the two –

  Comparison point	ULIP	Mutual funds
  Investment purpose	Insurance and investment	Investment
  Mode of payment	Premiums which can be paid once (single premium), for a limited tenure (limited premium) or throughout the policy tenure (regular premiums). Moreover, you can get different premium payment frequencies like annual, half-yearly, quarterly and monthly	Lump sum or SIP at periodic frequencies
  Charges	A range of charges are applicable to the investor, like premium allocation charge, policy administration charge, fund management charge, mortality charge, etc.	Investor may have to bear an entry load or exit load. Other charges, if any, are deducted in the form of Total Expense Ratio   from the invested amount.
  Regulatory body	Insurance Regulatory and Development Authority of India (IRDAI)	Securities and Exchange Board of India (SEBI)
  Minimum investment	Depends on the type of policy selected	Depends on the type of mutual fund selected

   

  Factors to be considered while choosing between ULIP and Mutual Funds

   

  When choosing between ULIPs and mutual funds, here are some factors that can be considered –

  1. Insurance coverage – assess your coverage needs and then choose between the two.

  2. Investment horizon – Identify your investment horizon, i.e., for how long can you stay invested and then see whether ULIPs or mutual funds will align with your horizon

  3. Investment amount – estimate how much you want to save and then see which investment avenue aligns with your savings

  4. Tax implication – plan your taxes in advance and choose an avenue which would give you the desired tax efficiency

  5. Charge structure – also compare the charges of ULIPs and mutual funds when choosing between the two

   

  Conclusion

   

  Both ULIPs and mutual funds help you save and create a financial corpus for your goals. However, these investment avenues have their fair share of differences. So, understand what they are, how they work and know their respective pros and cons. Choose an avenue which would suit your investment preference and prove to be a good investment choice. You can also invest in both ULIPs and mutual funds to create a diversified portfolio and also to enjoy the benefits of both.

   

  FAQs

   

  1. What is the lock-in period under ELSS schemes?

     ELSS mutual funds have a lock-in period of 3 years.

  2. How are mutual funds taxed?

     Mutual funds are taxed based on the type of fund selected and the investment tenure. If you choose a fund which invests at least 65% of its portfolio in equity, the fund will be called an equity fund. Gains from equity funds would be called short-term capital gains if you redeem the fund within 12 months. Such gains would be taxed at 15%. However, if you redeem after 12 months, the gains earned would be called long-term capital gains. Such gains would be tax-free up to Rs.1 lakh a year and excess gains would be taxed at a flat rate of 10%⁸. Capital gains earned from debt funds will be taxed at your income tax slab rates irrespective of the holding tenure⁸.

  3. Is the Section 80C tax benefit for ULIPs available under the new tax regime?

     The new tax regime does not allow deduction under Section 80C for premiums paid for ULIPs. If you want to claim 80C deduction, you should file your taxes under the old tax regime.

   

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