Apart from mortality charges, Ulips have many other charges like premium allocation, fund management, administration charges etc
Ever since the long-term capital gains (LTCG) tax has been introduced on gains from equity mutual funds, there is a buzz among investors if investing in Unit Linked Insurance Plan (ULIP) is better than investing in mutual funds (MF). Before we get to a conclusion, it is important to understand both the product.
ULIP is an investment-oriented insurance plan: In ULIPs, a small portion of your premiums go towards providing an insurance cover and the rest of it gets invested, in a fund of your choice. The funds are managed by a fund manager and you are allocated units of the selected fund.
On the other hand, mutual funds are purely an investment vehicle, that pool in the savings of many investors and invest them in diversified instruments. They are managed by fund managers, who invest the money in line with the investment objective of the fund.
Now let us understand which is a better option – ULIPs or mutual funds?
Charges: Apart from mortality charges (cost of insurance), ULIPs have many other charges like premium allocation, fund management, administration charges, surrender or discontinuance charges and switching charges, etc. These charges reduce overall returns from the policy.
In comparison, the costs associated with investing in mutual funds, are much lower. Generally, mutual funds have fund management charges and exit load (if any on early redemption).
Returns: In ULIPs, the charges are deducted from the premiums paid, and only the net premium gets invested. Hence, considering ULIPs have such high charges, the amount that gets invested to generate returns, is much lower than the actual premium paid. This significantly impacts the returns that ULIPs can generate.
It is evident from the data, that even if we consider the impact of LTCG of 10% on historical returns, mutual funds have still outperformed ULIPs.
Liquidity: ULIP investments have a lock in period of five years. This makes ULIPs an illiquid investment. Hence in case of any emergency, you cannot encash your policy.
MFs on the other hand, are a more liquid form of investment. Open-ended MFs have no lock in and can be liquidated at any point of time. However, there may be minimal exit load charges applicable, if funds are redeemed before a specified period (usually one-three years).
Tax Saving: If one is investing in ULIP to get benefit of 80C deduction, a better option would be to invest in ELSS (Equity Linked Savings Scheme). ELSS is a MF that qualifies for the same deduction. Further, it has lock in of three years only, as compared to the five-year lock in period of ULIPs. In addition to better liquidity, ELSS have generated much better historical returns than ULIPs, in the long run.
The reason ULIP policies are popular among investors, is because they are marketed and sold as a great investment option, that also provide insurance cover. Mis-selling of these products is rampant in the industry, as insurance agents are given huge commissions for selling them. Investors find them more attractive as along with insurance they get some money back, as compared to term policies.
However, the fundamental rule should be that you should ‘Never mix investment with insurance’. It is much wiser to opt for a cheaper term plan, than investing in a ULIP. Considering you will pay a much lower premium for the same cover, you can invest the balance directly in mutual funds.
THE PROS & CONS
- Apart from mortality charges, Ulips have many other charges like premium allocation, fund management, administration charges etc
- Open-ended mutual funds have no lock-in and can be liquidated at any point of time
- The lock-in period of five yars makes Ulip an illiquid investment
The writer is CFA, founder and chief happiness officer, HappynessFactory.in
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