How do mutual fund investments still outscore ULIPs?

A choice between ULIPs and mutual fund investment has usually been a task for investors! However, the comparison between the two took a new direction when long term capital gains (LTCG) tax on equities was re-introduced in 2018. This article will explain if LTCG has made ULIPs a better choice of investment or mutual funds continue to rank high on the popularity index.

Investments in Unit-Linked Insurance Plans (ULIPs) and mutual funds have been two popular options to capitalize on equities in the long term, while avoiding the direct stock market chaos. Both routes direct your investments to equities, but have slightly different offerings. While mutual fund investments yield returns based purely on your investments in the market, ULIPs additionally offer life cover and hence promises a ‘sum assured’ at the end of the tenure.

Difference between ULIPs and mutual fund investments

There are several basic differences between ULIPS and mutual fund investments:

  1. Lock-in period: Since ULIPs come under insurance products, the minimum lock-in period is 3-5 years.

Mutual funds on the other hand, do not have a lock-in period, except for tax-saving ELSS which have a lock-in of only 3 years.

  • Transparency: As ULIPshave an additional insurance component, the asset allocation and underlying expenses make them a less transparent financial product.

Comparatively, mutual fund investments are transparent when it comes to portfolio holdings and fee charges.

  • Expenses: Charges for ULIPs are comparatively higher than those of mutual funds.
  • Tax Benefits: Investment in ULIPs is eligible for Income Tax deduction under Section 80C.

However, barring ELSS, investments made in mutual funds are not eligible for tax benefits.

Long-term capital gains tax (LTCG): A game-changer?

Any profit (of over Rs. 1 lakh) made on the sale of stocks and/or equity-oriented mutual funds held for a time period of more than 12 months before the transfer is now liable for LTCG. And re-introduction of LTCG in 2018 Union Budget was said to be game-changer when it came to making a choice between ULIPs and mutual funds.

As per the ruling, ULIPs stayed out of the LTCG tax ambit, while mutual fund investments fell under it. This, in investors’ minds, gave a considerable edge to ULIPs as an investment choice. However, financial analysts believe that investment choices should not be based merely on one criterion.

Mutual fund Vs ULIPs after LTCG

After the LTCG ruling, though ULIPs get an added advantage of being free from the liability of the tax, there are several other factors that continue to keep mutual funds ahead. As discussed above, mutual funds already emerge as winners on the following parameters:

  • Lower investment costs
  • Higher liquidity
  • Higher transparency

Besides these, in mutual fund investments, with higher transparency comes greater flexibility. Since you are always aware of the mutual fund portfolio and charges, etc., it becomes easier to track your investment’s performance and accordingly decide to add, reduce, sell or switch. On the contrary, if you redeem your ULIP investment, you also lose the insurance cover. At the most, you can switch to a different fund, but with the same company, eventually forcing you to stay with the same insurance company.

Mutual fund returns are higher as it is mainly dictated by the market movements and investment charges are lower. ULIPs on the other hand, may seem to be a better investment option with the added benefit of a life cover, but that comes with a cost. Since ULIPS have to pay a sum assured whether or not the investment makes money in equities, the customer is charged accordingly. This results in lower returns.

Besides these, if you invest in mutual funds and a separate term insurance plan instead of a ULIP, you can get a higher life cover. In an ideal case, your life cover should be approximately 10-15 times of the annual income. ULIPs however give only around 10 times of your income. Therefore, a combination of mutual fund and term insurance investments can get you a better deal in the long run.

Conclusion: When it came to the subject of taxability, ULIPs always had an edge over mutual funds and LTCG only added to it. Nevertheless, mutual fund investments continue to score on a number of parameters to overtake ULIPs as the more viable option to invest in equities.

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