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ULIPs or Mutual Funds: Where to invest?

Investors often face the choice between Unit Linked Insurance Plans (ULIPs) and mutual funds when looking for market-linked investment options. Both ULIPs and mutual funds offer opportunities for wealth creation, but they have distinct features and serve different purposes. ...Read More

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ULIPs or Mutual Funds: Where to invest?

Should you invest in ULIPs or Mutual Funds
July 01, 2024

Table of Content

 

In this policy, the investment risks in the investment portfolio is borne by the policyholder

Common investment goals include buying a car, owning a home, funding a marriage, going on foreign vacations and more. There are a number of high-yield investment options in the market that allow you to reach these goals. All of these are market-linked investments and carry significant risks. 

Mutual funds and ULIP are two options that allow investors to mitigate risks involved with market investments. These two stand out as one of the most preferred options amongst investors looking for a safer alternative to direct stock investments. 

In this article we will deep dive into understanding ULIP & mutual funds and will try to understand the differences, points to remember and more.

Difference Between ULIP and Mutual Fund - Which is Better?

The better option between ULIP and mutual funds depends on your investment goals, risk appetite and time horizon. ULIPs provide life insurance coverage and investment at the same time, while mutual funds only allow you to create wealth. On the other hand, mutual funds typically offer better returns over a long period.

To understand which is the better option, you need to take a deeper dive into the features and differences between mutual funds and ULIPs. Understand their pros and cons to decide which suits your needs. 

What Is a Mutual Fund?

A mutual fund is nothing but an investment vehicle which collects funds from many investors (individual or institutional). It invests the accumulated funds in a portfolio of securities such as stocks, bonds, debentures and money market instruments. The company that undertakes the entire activity is known as AMC or Asset Management Company. 

AMCs or fund houses offer numerous types of mutual fund schemes based on different investment objectives. The return on investment generated by the fund is equally distributed among the investors who are also known as unit holders and a small percentage of the return is levied on the investment in the form of expense ratio. 

You can invest in a mutual fund in two modes namely systematic investment plan (SIP) and lump sum. Under a systematic investment plan, investors will have to make investments after regular intervals which start from a minimum amount as low as Rs. 500. While under a lump sum, investors make a one-time payment in a single go.

What is a Unit-Linked Insurance Plan (ULIP)?

Unit Linked Savings Plan popularly known as ULIP is a type of life insurance policy which provides both insurance cover and investments. It allows the policyholder to create wealth over the long term along with a term insurance cover.

By availing of a ULIP policy, you can choose how much you are willing to invest and how much insurance covers. As a policyholder, you can choose between equity, debt and hybrid funds to invest in and switch between funds throughout the policy term. Moreover, you can get double tax benefits under Section 80C and Section 10(10D) on the IT Act subject to certain conditions.

Differences between ULIP and Mutual Fund

The choice between ULIP vs Mutual Fund has always been a controversial matter among investors. Here is a list of their differences explained: 

Tax Benefit

  • ULIPs: Tax Benefits

    Primarily there are two tax benefits which you can get from ULIP. First, you can claim tax deductions on paying insurance premiums of up to Rs. 1.5 lakh under Section 80C# of the Income Tax Act. Also, the maturity proceeds generated from the policy are exempted from tax under Section 10(10D)# for premium amounts below Rs. 2.5 lakh per annum. For premiums worth Rs. 2.5 lakhs per annum or more, the LTCG maturity proceeds are taxed at 10% on gains above Rs. 1 lakh. For short-term capital gains (STCG), the tax rate is 15% on the total capital gain.

  • Mutual Funds: Tax Benefits

    Among mutual funds, only a special type of equity scheme known as Equity Linked Saving Scheme (ELSS) is eligible for tax deductions under Section 80C#. However, the capital gain from an ELSS is taxed similarly to another mutual fund which is 15% for short-term capital gains (STCG) and 10% without indexation for long-term capital gains (LTCG). LTCG of up to Rs. 1 lakh is tax-exempt. 

Return on Investment

  • ULIP: ROI

    Unit Linked Saving Plan is a combination of insurance and investment. When compared against pure investment options, the return on investment (ROI) on ULIPs is impacted due to the added insurance cost. It offers insurance benefits but might have higher charges which can largely impact your ROI. 

  • Mutual Fund: ROI

    Mutual funds are purely an investment product with the potential of a sizable amount of return. Moreover, it offers the investor more flexibility and transparency leading to a better ROI as compared to ULIPs. The ROI of mutual funds is dependent on the performance of their underlying assets, which relies on various market factors.

Life Insurance Cover

  • ULIP: Insurance Cover

    ULIP being a type of insurance product provides insurance coverage to the policyholder. It offers triple benefits such as investment return, insurance cover and tax benefits.

  • Mutual Fund: Insurance Cover

    A mutual fund is purely an investment product and does not have any insurance cost embedded in it. 

Lock-in Period

  • ULIP: Lock-in

    Similar to any tax-saving investments under Section 80C#, ULIP plans come with a lock-in period of 5 years. Hence, if you have a short-term goal, ULIP may not be a good choice. But it can be beneficial if you are planning for long-term investment objectives of at least 5 years.

  • Mutual Fund: Lock-in

    A mutual fund does not have any lock-in period except ELSS (Equity Linked Saving Scheme) and some solution-oriented funds such as retirement funds or children's funds. But the rest of the mutual fund schemes such as large-cap, mid-cap, multi-cap, flexi-cap, corporate bond funds etc., can be redeemed at any time. 

Rebalancing and Switching

  • ULIP: Switching

    In ULIPs, the rebalancing and switching facility is one of the biggest advantages. It allows you to transfer units fully or partially from one fund to another without any charges or exit loads or neither attracts any kind of taxes. It can be beneficial for investors who stay updated about the market and want to change their asset allocation without incurring penalties. 

  • Mutual Fund: Switching

    In mutual funds, whenever you are willing to rebalance your portfolio and change the current allocation, you will have to sell the units from one fund and invest the same in another. This brings the concept of capital gain taxes whenever you are selling your units and some funds might also charge an exit load with withdrawal within a stipulated time frame.

Factors to Consider Before Deciding Between ULIP and Mutual Fund

ULIP vs Mutual Fund has always been a controversial matter among investors. Here is a detailed discussion of the key factors to consider before deciding between a ULIP and a mutual fund:

Tax Benefit:

Before deciding between the two, the main aspect which you will have to consider is tax advantages. By opting for a ULIP you get to avail tax deductions on premium payments under Section 80C and exemption on maturity proceeds under Section 10(10D)#. 

However, if the annual premium paid is more than Rs. 2.5 lakhs, the long-term capital gains are taxed at 10% on gains above Rs. 1 lakh. For short-term capital gains (STCG), the tax rate is 15% on the total gains.

On the other hand, there are no tax deductions available on a mutual fund investment except for ELSS. Investors can benefit from a tax deduction of up to Rs. 1.5 lakhs by investing in an ELSS. Considering this, investors should assess their tax liability to choose the better option between ULIP plans and mutual funds.

Portfolio Flexibility: 

As a ULIP policyholder, you will get more portfolio flexibility than mutual fund investors. In a ULIP, you will get to choose how much amount shall go to life insurance and how much must be invested. In the investment component, you can even choose to select the percentage which is to be invested in equity and debt. 

In a mutual, the investor has to select the scheme based on the investment objective and risk appetite. They only have the option to enter and exit the investment. 

Risk Factor:

When deciding between mutual funds and ULIPs, the risk factor is one the most crucial factors to consider. Mutual fund investments have a higher amount of risk associated with them compared to a ULIP policy of the same type. 

Hence, as a conservative investor, you can count on a ULIP because you will receive the term insurance payout even if your market-linked returns are on the lower side.

Comparison Between Mutual Funds and ULIPS

Listed below is a detailed comparison between a mutual fund and a ULIP policy

Basis

ULIPs

Mutual Funds

Purpose

To generate wealth alongside providing life insurance cover

To create long-term wealth

Regulatory Body

Regulated by the Insurance Regulatory and Development Authority of India (IRDAI) 

Regulated by the Securities and Exchange Board of India (SEBI) 

Duration or Policy Term

Long term

The duration of investment can be as short as one day

Lock-in Period

5 years

No lock-in period except for ELSS funds (3-year lock-in period) and some solution-oriented funds

Tax Benefits

Eligible for deduction up to Rs. 1.5 lakh under Section 80C. Maturity proceeds are tax-exempt under Section 10(10D)

No tax benefits except for ELSS. ELSS investors are eligible to claim deductions under Section 80C 

Management Expenses

Maximum- 1.35%

Maximum- 2.5%

Mode of Investment or payment

Lump sum investments or regular premiums on specific intervals

SIP or lump sum

Risk Factor

Low to high-risk

Depends on the scheme objective and the asset allocation of the investment

ULIPs vs Mutual Funds: Which One to Choose?

ULIP is a unique investment option which comes with the privilege of life insurance cover. It also allows the policyholder to enjoy some perks like loyalty benefits, tax benefits and seamless transfer and switching options. 

On the other hand, a mutual fund is a pure investment option which allows you to take direct exposure to the equity market, fixed-income securities or money market instruments. While it does not provide the additional benefits offered by ULIP, it’s better as a pure investment option. 

Hence the choice between ULIPs and mutual funds depends on figuring out how each product fits into your overall financial strategy. 

There are some factors which must be taken into consideration while making an informed decision such as performance expectations, liquidity requirements, tax implications, mortality charges at your age, etc.

Summing Up

To sum up, both ULIPs and mutual funds are good investment options if they align with your financial objectives and risk tolerance. For example, if you are looking forward to making investments which are highly liquid and offer higher returns, a mutual fund can be a good choice. But if you have a long-term objective, low-risk tolerance and the need for life insurance coverage for your loved ones along with tax benefits, ULIP could be the better choice. 

Frequently asked questions

  1. ULIP vs mutual fund- Which is better?

    In terms of tax benefits, ULIP offers more tax benefits compared to mutual funds while mutual funds have higher return generation potential. There is a lock-in period of 5 years with ULIPs while there is no lock-in period for mutual funds (except ELSS). You can determine which one is the best by keeping several things in mind such as your returns expectations, liquidity requirements, tax implications, etc.

  2. Is it good to invest in ULIP?

    Yes, ULIP can be a good investment option if you have long-term objectives, low-risk tolerance and if you are looking for life insurance coverage along with tax benefits.

  3. What are the tax benefits of ULIP?

    ULIP has tax benefits for making the premium payment under Section 80C and capital gains are tax-free under Section 10(10D). However, if the annual premium paid is more than Rs. 2.5 lakh, then the long-term capital gains shall be taxed at 10% on gains above Rs. 1 lakh. For short-term capital gains (STCG), the tax rate is 15% on the total capital gain.

  4. When is the best time to make mutual fund investments?

    The best time to make a mutual fund investment is as early as possible. It is mainly because the longer you stay invested, the more benefit of compounding you will be able to reap.

  5. Which is a more flexible investment – ULIP vs mutual fund?

    ULIP and mutual funds both are flexible investment options. However, ULIPs allow you to switch between different funds without paying anything extra, allowing you to change the asset allocation based on a change of needs. Unlike ULIPs, mutual funds allow you to make redemptions at any time with the exception of ELSS. However, you may have to pay an exit load for an early withdrawal.
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Francis Rodrigues Francis Rodrigues

Francis Rodrigues has a decade long experience in the insurance sector, and as SVP, E-Commerce and Digital Marketing, HDFC Life, manages the online sales channel, as well as digital and performance marketing. He has had hands-on experience in setting up sales channels and functional teams from scratch over a career spanning 2 decades.

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#The above tax benefits are subject to conditions specified u/s 80C and u/s 10(10D) of the Income tax Act, 1961. The afore stated views are based on the current Income-tax law. Tax Laws are also subject to change from time to time. The customer is requested to seek tax advice from his Chartered Accountant or personal tax advisor with respect to his personal tax liabilities under the Income-tax law.

The Unit Linked Insurance products do not offer any liquidity during the first five years of the contract. The policyholders will not be able to surrender or withdraw the monies invested in Unit Linked Insurance Products completely or partially till the end of fifth year.

For more details on risk factors, associated terms and conditions and exclusions please read sales brochure carefully before concluding a sale. Unit Linked Life Insurance products are different from the traditional insurance products and are subject to the risk factors. The premium paid in Unit Linked Life Insurance policies are subject to investment risks associated with capital markets and the NAVs of the units may go up or down based on the performance of fund and factors influencing the capital market and the insured is responsible for his/her decisions. HDFC Life Insurance Company Limited is only the name of the Insurance Company, The name of the company, name of the contract does not in any way indicate the quality of the contract, its future prospects or returns. Please know the associated risks and the applicable charges, from your Insurance agent or the Intermediary or policy document of the insurer. The various funds offered under this contract are the names of the funds and do not in any way indicate the quality of these plans, their future prospects and returns.

18. Save 46,800 on taxes if the insurance premium amount is Rs.1.5 lakh per annum and you are a Regular Individual, Fall under 30% income tax slab having taxable income less than Rs. 50 lakh and Opt for Old tax regime.

** The past 5 year fund performance of HDFC Life Discovery Fund (SFIN: ULIF06618/01/18DiscvryFnd101) as on 30th November 2024. The benchmark taken into consideration here is is Nifty Mid Cap 100 which as a return of 26.77% as on 30th November 2024. HDFC Life Discovery Fund is available with HDFC Life ULIPs which comes with a life cover. Please note past fund performance is not indicative of future performance.

ARN - INT/MC/01/24/7453

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