Most of us require lump sum amounts at various life stages for buying a home, higher education costs for children, retirement and other goals. While comparatively low-risk options (like guaranteed return schemes) are available for investors, the age-old premise of no risk and no reward seems to apply to most good investment plans. It is especially applicable in the case of two of the most popular ones available today, i.e. mutual funds and ULIPs. So, should you choose a ULIP policy over a mutual fund or vice versa? Here’s the lowdown.
What are ULIPs?
A ULIP policy is an insurance product where investors get both life insurance and market-linked investment returns. They get life coverage throughout the policy tenure while earning returns from investments in market-linked instruments like bonds, equity shares, etc. Of course, you can always use an online ULIP plan calculator to estimate your future returns over a sustained duration.
What Are Mutual Funds?
As opposed to ULIPs, mutual funds follow a different framework. They pool money from investors to directly invest in several debt and equity-related market instruments. These funds come with professional management, and fund managers go ahead with investment decisions in response to market conditions. There is a large variety of mutual funds available for investors today.
Differences between ULIPs and Mutual Funds
Even if you think that the core premise of both these investment options is the same, several differences still exist. Here are some of the top aspects that need to be examined:
- ROI (returns on investments) – When compared with the same amount of investment, ULIP policy returns are slightly lower since these plans are not pure investments and have an insurance component that offers a guaranteed sum assured, which is outside the purview of the performance of the investment. Otherwise, the returns are linked to financial instruments like Equity, Debt, and Balanced and Liquid Funds, all of which have varying degrees of risk and returns.
On the other hand, mutual funds have no insurance component that guarantees a sum assured. They may have varying returns based on the level of risk. Equity funds may generate higher returns while having the highest volatility and fluctuation risks. Debt funds have comparatively lower risks but lower returns as well. There are balanced funds which are a mix of both equity and debt funds, carrying even lower risk levels.
- Lock-In Periods – ULIPs come with a mandatory five-year lock-in period. Investors cannot withdraw money before this period. After this period, partial withdrawals for the accumulated corpus are allowed. At the same time, mutual funds have one-year lock-in periods in most cases, while ELSS funds (Equity Linked Savings Scheme) have a three-year lock-in period.
- Plan Components – A ULIP policy is a dual benefit policy with insurance and investment in the mix. This means a more intricate structure in terms of charges and allocation of assets. Mutual funds do not come with dual benefits, i.e. they only offer returns on investments depending upon market performance. They also have associated costs and fees for fund management.
- Tax Benefits – Investing in ULIPs will get you tax benefits up to Rs. 1.5 lacs per year under Section 80C of the Income Tax Act of 1961. However, you can only get tax benefits with your mutual fund investments if you invest in ELSS funds. Additionally, the gains from mutual funds are taxable. In contrast, under ULIPs, the maturity/death benefits are exempt from taxation under Section 10D of the Act mentioned above if the total yearly premiums don’t exceed Rs. 2.5 lacs.
- Charges – ULIP policy charges can sometimes be slightly higher than mutual funds. Still, most of these charges have been capped by IRDAI (Insurance Regulatory and Development Authority of India), and their impact on the returns diminishes in the long run. On the other hand, SEBI (Securities and Exchange Board of India) has restricted the expense ratio to 1.05% for Mutual funds.
- Coverage for Risks – Quite obviously, ULIPs have integrated insurance coverage for the investor, i.e. there is a guaranteed sum assured for their family in the event of their unfortunate demise within the policy period. Yet, mutual funds do not have any coverage for risks of this sort. You will separately have to invest in a life insurance plan and pay an extra premium for the same as well.
- Flexibility and Fund Rebalancing – The fund switching and rebalancing feature is one of the most significant benefits of a ULIP plan. ULIPs enable policyholders to transfer units entirely or partially across funds without incurring exit loads or other taxes. This is undoubtedly a significant advantage over mutual funds for investors who frequently modify their asset allocation and try to time the market. Mutual Funds do not offer such facilities. In mutual funds, one must sell some equity units and buy corresponding debt units to rebalance their portfolio from one asset class to another (for instance, from equities to debt).
Which one should you choose and why?
Choosing between a ULIP policy and a mutual fund is not a one-size-fits-all formula. Mutual funds are more suitable for those looking for higher levels of liquidity. They are also more suitable for those with medium/short-term investment goals. Those with a higher appetite for risk may also consider mutual fund investments as the way forward towards aggressively building a future corpus.
ULIPs are suitable for those with a long-term investment horizon and those who desire integrated life coverage with their investment scheme. Those with a medium or low appetite for risk may also find ULIPs to be more suitable investment choices. As mentioned earlier, they also ensure higher tax savings for policyholders under Sections 80C and 10D.
You should take your time before zeroing in on a suitable future investment channel. ULIPs are a preferred option for most people since they offer dual benefits and tax deductions. However, mutual funds also have their fair share of advantages. Many prefer to start with ULIPs for long-term life coverage and returns while adding some mutual funds to their portfolio with increasing age and income. Do your research, choose prudently and do not put all your eggs in a single basket, as another age-old mantra clearly states.