Both ULIPs and mutual funds have many similarities which is why they are often compared against one another. Investors have an unending debate on the benefits of mutual funds over ULIPs and vice versa. Some say mutual funds are better while others say ULIPs are. What do you think?
If seen in depth, if you have a longer investment horizon (more than 7 years), some ULIPs gain better score than mutual funds. Let’s explore the various aspects to support the claim and know the ground reality:
You get life cover under ULIPs
The distinctive feature of a unit linked plan is that it combines insurance cover along with market-linked returns. That is why ULIPs give you something extra which mutual funds don’t – life insurance protection. While in mutual funds you only get the fund value of investments you have made in case of early death, in case of a unit linked plan you get a Sum Assured or Fund value whichever is higher. Since life is unpredictable, having the security of life insurance protection makes ULIPs better than mutual funds.
The cost of the life cover is low
Against the availability of life cover in ULIPs, investors often debate that a combination of mutual funds and term insurance rivals the benefits of ULIPs. Are they right? Technically, they are but is it the whole picture?
When you buy a term plan with a mutual fund scheme, you are essentially combining life cover with investment returns. Though you think the combination is better than ULIPs, you ignore the costs involved. In ULIPs, there is a mortality cost for the life cover provided. This cost is levied on the sum at risk which, in simple terms, is sum assured less the fund value. As you pay subsequent premiums and the fund value grows, the sum at risk reduces and then becomes zero after a certain period. As soon as the sum at risk becomes zero, mortality cost is not deducted. Therefore, in a unit-linked plan, you bear the cost of insurance only for a short duration. In case of a term plan, you pay higher premiums compared to the mortality cost charged in ULIP and that too for a longer duration. So, which saves you more money – Term plan with mutual funds or ULIPs?
ULIPs have lower charges
Many individuals argue that ULIPs have a range of charges like the premium allocation charge, administration charge, fund management charge, mortality charge, etc. These charges make ULIPs unattractive.
While the charge structure in ULIPs was always a negative point, new plans available in the market address this concern. Many unit-linked plans have reduced the allocation charge drastically. Where the allocation charge is applicable, it is either reduced or nullified from the second or third policy year. Even the policy administration charges in many plans have been reduced to zero. In fact, over a long run, the average charges in a unit linked plan become very much competitive in comparison to overall charges in mutual funds. It even rivals the expense ratio of a mutual fund scheme. So, if you are investing with a long-term perspective and buy plans with a lower charge structure, you wouldn’t have to worry about the inherent costs in a unit linked plan.
ULIPs follow passive investment strategy compared to Mutual Funds
Mutual funds are better for high risk-taking individuals because they churn out more stocks in comparison to ULIP Funds. Even if you invest in debt mutual funds, the risk is high because of active participation in market movements and frequent churning of underlying assets. In a ULIP, on the contrary, the passive investment strategy is followed and there is less churning making it comparatively less risky.
You can create disciplined savings
Mutual funds (except ELSS plan) are liquid in nature. You can redeem your fund any time you want to, by paying the applicable exit loads. This liquidity, though helpful in a financial crisis, tempts you to withdraw your funds early. This temptation does not allow you to create disciplined savings for your future goals. ULIPs have a five year lock-in period wherein withdrawals are not allowed. As such, a unit-linked plan forces you to create wealth and makes you financially disciplined. These forced savings give you a good corpus which helps you in meeting your financial obligations in future. If liquidity is a concern, in case of an emergency, many banks provide a loan against these policies.
The tax angle makes ULIPs unbeatable
When you consider the tax implication on mutual funds and ULIPs, ULIPs emerge as the clear winner. With the recent announcements of the Union Budget, 2018, equity mutual funds attract a long-term capital gain tax of 10% if the returns exceed Rs.1 lakh. While earlier such returns were tax-free, now they are taxable.So now the story is that Short term or Long-term capital gains from all mutual funds are taxable. This tax implication makes mutual funds less attractive.
ULIPs, on the other hand, give you three types of tax benefits. The investment you make is allowed as a tax deduction under Section 80C up to Rs.1.5 lakhs. The maturity and death benefit is also completely tax-free under Section 10 (10D). Moreover, any partial withdrawals that you make or the surrender value you receive are also tax-free in your hands. Thus, ULIPs give you an all-around tax benefit which is conspicuously missing in mutual fund investments.
Another tax incidence can be seen in case of switching. If you switch between mutual fund schemes, i.e. from equity to debt or vice versa, you would attract long term or short term capital gains tax, depending on the tenure of investments. In ULIPs, however, switching between the different funds is completely tax-free. Whether you park your returns in a debt fund or move to an equity fund for attractive returns during the plan tenure, any switching is completely tax-free. You can, therefore, change your investment strategies in a unit linked plan as frequently as you want without worrying about the tax implication.
Aren’t these reasons good enough to tilt the scales in the favour of unit-linked insurance plans? ULIPs score points over mutual funds because of these inherent benefits which you don’t find in a mutual fund scheme. The biggest advantage of ULIP investment is the tax relief which you get. This tax relief is not allowed with any other market-linked investment. So, understand the advantages ULIPs have over mutual funds before you make your investment decision.
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