Unit Linked Insurance Policies (ULIPs) are aggressively promoted as a great combination of investment and insurance by salesmen who make hefty commissions. This is the only reason why they are pushed so hard and also find so many buyers. While they may appear similar to Mutual Funds – they also have Units that have daily Net Asset Values (NAVs), scratch the surface and you will find major differences. The difference between ULIPs vs Mutual Funds shown below.
ULIPs vs Mutual Funds(ELSS): A Quick Comparision
• Overhead charges – Mutual Funds lean, ULIPs – massive (covered above) that reduce your returns.
Score: Mutual Fund 1, ULIP – 0
• Surrender charges – Mutual Fund has some exit loads for usually up to 1 year, but ULIPs have higher charges; Agents want you to think that your money if fully locked for 5 years.
Score: Mutual Fund 1, ULIP – 0
• Cost of Insurance – Buying a Term Plan with a Mutual Fund has far lesser cost, compared to ULIP
Score: Mutual Fund 1, ULIP – 0
• Lock-in period: ELSS Mutual Funds has 3 years whereas ULIPs have three to five years.
Score: Mutual Fund 1, ULIP – 0
• Tax Implications: Long term capital gains are 0% after 1 year, in case of ULIPs maturity amount is tax-free. Both have similar tax benefits under Section 8OC
Score: Mutual Fund 1, ULIP – 1
Final Score: Mutual Fund 5, ULIP – 1
Mutual Funds score better in lower costs (and hence give higher overall returns). They are high on flexibility.
Insurance Coverage
Mutual Funds do not provide insurance, but you can always buy it separately. To put it crudely: With a ULIP, Investment + Insurance is like 1 + 1 but you pay 3 for it. Whereas with Mutual Fund, you pay 1 each separately ending up paying only 2. To understand the actual difference in the Total Cost of a ULIP vs Total Cost of Mutual Fund, you need to simply break down the costs of these two components and the annual trail commissions that are paid to the ULIP salesmen.
As a smart buyer, you need to understand how much insurance you really need. Unfortunately, ULIPs are pitched to many people who don’t really need insurance. For example, senior citizens do not need insurance as they are assumed to have no dependents on them. Middle-aged people who have sufficient assets to cover any life needs for their families may need only small life insurance but they are also made to buy large ULIPs.
Switch between Equity and Debt
ULIPs may offer the ability to ‘switch’ between equity and debt ‘for free’ but many people do not really use this feature and are not aware of the conditions included. Mutual Funds, on the other hand, have no such restrictions as you can choose between various Mutual Funds based on your risk profile.
Lock-in Period
ULIPs have a higher lock period ranging from 3 to 5 years. With Mutual Funds, there is no such lock-in. Even if you do invest in Tax Saving Mutual Funds (ELSS), the lockin is a maximum of 3 years.
Tax Benefit
In a Unit Linked Insurance Plan (ULIP) the entire amount invested can be exempted from tax, up to a maximum of Rs 1,50,000 under Section 80C. Agents pushing ULIPs will tell you that it is a smart way to get both benefits in one shot. But this comes at a significant cost of both upfront commissions, trail commission, high insurance mortality cost, premium allocation charges and fund management charges. There is also a lock-in period involved.
Haven’t ULIPs Reformed and Become ‘Better’ Products?
So you can see that a ULIP is basically an insurance product that charges a part of the premium to cover benefits under death (aka “mortality” charges), and puts the rest into a mutual fund equivalent.
When they were launched in the early 2000s (coincidentally the ‘sunrise’ years of the private life insurance industry), they were touted as better than endowment products. However, due to huge commissions and payouts made, agents rampantly mis-sold the product to customers. Many investors lost a considerable part of their wealth due to investing in ULIPs.
The regulator (IRDAI) did step in to regulate the ULIPs. So ULIPs have better disclosures and some caps on costs and commissions. However, when compared to ELSS Funds the above score still stands!
How to Save Tax?
It is said that in life only two things are certain. One is death. The other is taxes!
We all know that death cannot be avoided (however there is a lot of research these days on how to delay aging and live a long healthy life).
Taxes, is well, another story. There are many ways to legally reduce your tax burden. You need to be smart about tax planning and choose the right instrument. In India, we have the so-called Small Savings investment schemes such as Public Provident Fund (PPF), National Savings Certificate (NSC), Employee Provident Fund (EPF), etc.
Tax Saver Mutual Funds (ELSS)
Equity Linked Savings Schemes (ELSS) are Mutual Funds that invest in equities and have a lock-in period of 3 years. This is the least lock-in period for a Tax Saving instrument. The charges involved are primarily funded management charges.
If you are one of those investors going for ‘Regular Plans’ then you also pay a high commission of about 1.5% per year. Overall you lose about 6% in one shot by going for a ‘Regular Plan’ sold by a broker.
Since this is an equity mutual fund, the long term capital gains are absolutely tax-free. The dividends you earn from the scheme are also tax-free! For more details, you can check the “Tax Savings Calculator” that is available for every ELSS fund in Jama’s App.
Conclusion
If you wish to buy insurance for protection, and you must – if you have a family that depends on your income for their living. Or if you have outstanding loans. In such a case just buy pure term life insurance. Invest the rest in a Tax Saver Mutual Fund.
During the Tax Season of the year, every investor looks for the best way to invest money and save tax at the same time. With the ‘Big Finance’ industry (brokers, distributors, banks) actively pushing products like ULIPs, there is a high level of awareness of ULIPs vs Mutual Funds, which mix insurance and investment. On this blog, we have already written about the dangers of mixing up insurance and investment, and also on how to gracefully exit out of a ULIP. But still, this question keeps popping up.
Instead of simply retorting, ‘I told you so’, it is our duty to keep repeating the basic financial wisdom again and again. This is not ‘whiz-dom’, it is actually quite simple. Though some people make it sound like it requires ‘whiz’ to confuse hapless investors and make a killing via fat commissions.