ULIPs and Mutual Funds, both, help you meet investment objectives. Both these investment tools help you access equity as well as debt instruments, thus helping you create wealth as per your risk appetite. However, there are plenty of differences between these two options, and it’s understandable for investors to get confused about which one’s a better option for them.
ULIPs, or Unit Linked Insurance Plans, allow an investor to get Life Insurance along with investment benefits. In this policy, a part of the premium paid is allocated towards mortality charges and an assortment of fees, while the rest is invested in market-linked securities. At the time of the policy maturity, the investor gets the sum assured or the fund value, whichever is higher.
Mutual funds are pure investment options with underlying assets such as equities, bonds, gold, commodities etc. Mutual funds can be entered or exited as per the investor’s needs. A small part of the investor’s funds are allocated towards management fees.
Let’s see some of the key differences between ULIPs versus Mutual Funds
This is the major difference between the ULIPs and Mutual funds. There is no sum assured in case of the vast majority of Mutual Fund schemes. However, there are a handful of Mutual Fund schemes that offer a linked term insurance plan. On the other hand, ULIPs, by definition, have a life insurance component. ULIPs are a combination of insurance and investment, and they offer a sum assured based on the premium. For example, an investor signs up for a ULIP paying an annual premium of Rs 50,000 for a sum assured of Rs 5 lakh. In case of the investor’s death in the second year (when the premium paid is less than the sum assured and hence the fund value, too, is lower), the insurer pays the nominee Rs 5 lakh. However, when the fund value surpasses sum assured, the nominee gets the fund value.
The fees in ULIPs include premium allocation charges, mortality charges, administration costs, and fund management fee. There may be a charge for premature redemption of ULIP. The charges are higher in case of ULIPs. It starts with about 4% in the initial years and gradually reduces to 2.25% in later years. Mutual fund charges are grouped together under what is called the expense ratio which includes fund management fee, administration charges, and any other fee. The expense ratio is about 2% to 2.5%. There is also an exit load for the redemption of Mutual Fund units held for less than one year.
Both Mutual Funds and ULIPs invest in market-linked securities such as stocks and bonds. Therefore, an investor’s returns from either instruments carries high risks, especially in the case of equity investments. However, all conditions assumed equal in both options, ULIPs may return lower investment yields in the initial years due to a higher fee structure.
ULIPs have a lock-in period of five years. This means it may not be redeemed or surrendered before the completion of five years. This makes ULIPs ideal for long-term financial goals. Mutual funds, on the other hand, have no lock-in period except ELSS (Equity Linked saving Schemes) funds which are mostly used for saving taxes. There’s a Mutual Fund for every investment horizon, and therefore they are a more flexible investment option than ULIPs.
This is one area where ULIPs have an advantage over MFs. ULIPs provide investors the option to switch from one fund to another. For example, if the market conditions permit, an investor can switch from a debt fund to an equity fund for higher returns on his ULIP. These switches can be done in a tax-free manner. Mutual funds also allow investors to switch between funds of the same asset management company. However, such switches are not tax-free: exiting a fund (even while simultaneously entering another fund) is considered a redemption. Therefore the appropriate rate of capital gains tax will apply.
Investment in ULIPs can be used for tax-saving purposes as long as the premium paid is not more than 10% of the sum assured. The saving comes under Section 80C of the Income Tax Act with a limit of 1.5 lakh. In case of Mutual Funds, there is no tax benefit except in the case of ELSS funds, where the investment can be claimed for tax deduction under section 80C.
If it’s Life Insurance you seek, you may want to give term plans a shot, as they are more cost-effective than ULIPs. If it’s investment you want to do with a high degree of flexibility, lower fee structures, and great, market-linked returns, Mutual Funds may be your best friends.