A sound investment strategy can aid you to increase your wealth and could secure your family’s financial future. ULIPs (unit-linked insurance plans) and mutual funds are both attractive investment vehicles for investors looking to create wealth in the long-term. However, comparing mutual fund investments with ULIPs is like comparing oranges with apples. Let’s understand the difference between ULIPs and mutual funds.
What is a mutual fund?
A mutual fund is a financial vehicle wherein an AMC (Asset Management Company) manages the money of several investors. The collected funds are further invested in different securities such as bonds, stocks, and money market instruments, etc. The performance of your mutual fund scheme is directly proportional to the performance of these underlying securities. Mutual funds are pooled investments that are managed by professionals known as fund managers. It is similar to boarding a flight, wherein the pilot takes all the passengers to a particular destination. In this instance, the pilot is the fund manager, the airport is the mutual fund scheme, and the passengers are the investors. Fund managers are mutual fund experts who have in-depth knowledge about the complexities and volatilities of the financial markets and make appropriate asset allocation decisions.
What is a unit-linked insurance plan?
A unit-linked insurance plan, or ULIP, is a combination of investment and insurance. ULIPs are insurance policies that offer an investor the potential to create wealth while simultaneously providing them with the security of a life cover. Under ULIPs, a part of the premium goes towards providing the investor with a life insurance cover. These charges are called mortality charges. The rest is pooled and invested in debt or equity instruments or a combination of both to help create wealth in the long-term.
Difference between ULIPs and mutual funds
To gain some perspective on ULIPs and mutual funds, you must first understand the difference between the two investment products. Following are some of the significant differences between mutual funds and ULIPs. 1) Investment objective A mutual fund is a pure investment product that offers the sole benefit of creating wealth and has potential to generate reasonable returns in the long-term. On the other hand, ULIPs are primarily an insurance product with the added advantage of being a market-linked investment. 2) Return on investment The returns on ULIPs can be dynamic as they invest in equity, debt, or a combination thereof. The returns on mutual funds vary too depending on the type of scheme opted for and can range from low to high. There is no guarantee of minimum returns in mutual funds 3) Lock-in period As ULIPs are insurance products, insurers define lock-in period of generally 5 years for these investments. Investors cannot redeem their investments before this lock-in period is over. On the other hand, most mutual funds, especially open-ended mutual funds, do not have a lock-in period, except for ELSS funds, which have a lock-in period of 3 years to be able to provide tax benefit under 80C (section limit of 1,50,000) 4) Transparency Recent regulatory amendments by the IRDAI have made ULIPs quite transparent; they now provide upfront information on fund allocation. In the case of mutual funds, fund houses are mandated to provide a detailed report of the mutual fund investments. Financial markets’ regulator SEBI has advised fund houses to provide detailed information on asset allocation, portfolio holding, active fund manager(s), fees charged, etc., w.r.t different schemes. 5) Taxation Tax on mutual funds: LTCG (long-term capital gains) and STCG (short-term capital gains) tax of 10% and 15% (plus applicable surcharge and cess) , respectively, is levied on equity funds depending on the holding period. For debt mutual funds, LTCG tax is levied at 30% (plus applicable surcharge and cess) after indexation, while STCG tax is levied according to the investor’s income tax slab. Equity-Linked Savings Scheme (ELSS) funds qualify for a tax deduction of up to Rs 1.5 lac under Section 80C of the IT Act, 1961 Tax on ULIPs: Returns on ULIPs are tax-free under Section 10(10D) of the Income Tax Act, 196. 10(10D) basically says, if the sum assured is less than the 10 times of annual premium, then 10(10D) is not applicable. Especially, if an insured charged with additional loading while issuing the insurance policy, then the returns are taxed. 6) Expense Investing in mutual funds incurs professional management fee as well as operational fee, collectively referred to as an expense ratio. Some mutual funds also charge an exit load, i.e. a charge for leaving the scheme. When it comes to ULIPs, the charge levied includes premium allocation charge, fund management charge, administration charge, mortality charge, etc. 7) Risk cover Under ULIPs, nominees are compensated for the sum insured in case of the policyholder’s untimely demise. However, in the case of mutual funds, the investments are transferred to the nominee.
8) Risk cover Under ULIPs, nominees are compensated for the sum insured in case of the policyholder’s untimely demise. However, in the case of mutual funds, the investments are transferred to the nominee. 9) Charges in Mutual Funds vs ULIP
Following charges may be applicable in ULIPs and Mutual Funds
ULIPs:
Switching Charges: If you are switching the invested amount from one fund to another fund, there could be charges levied
Fund Management Charge (FMC): The daily unit price is calculated allowing for deductions for the fund management charge, which is charged daily. This charge will be subject to the maximum cap as allowed by IRDAI
Mortality Charge: Every month we levy a charge for providing you with the death benefit in your policy. This charge will be t a k e n b y c a n c e l l i n g u n i t s proportionately from each of the fund(s) you have chosen. The mortality charge and other risk benefit charge are guaranteed for the entire duration of the policy term.
Partial withdrawal charge: This will be levied on the unit fund at the time of part withdrawal of the fund during the contract period
Policy Administration Charges & Premium Allocation Charges are levied during discontinuation period
Discontinuation charges may be applicable if premium payments are discontinued.
Mutual Funds:
Exit Load: When investors exit a mutual fund scheme within a specific period from the date of purchase, an exit load is levied on these individuals. AMCs impose an exit load on investors to discourage them from opting out of a mutual fund scheme prematurely. Moreover, this fee allows fund houses to reduce the volume of withdrawals.
Generally, fund houses charge an exit load of around 1% on redemption value. It is common for the fund houses to charge exit load if you as an investor redeem the units within a year. While there is no exit load is charged post one year of investment in the same scheme.
Expense Ratio
This charge is synonymous with mutual fund fees and charges for most investors. Expense ratio is an annual fee, which is expressed as a percentage of a fund’s daily net assets. It is charged by an asset management company for managing an MF scheme. Therefore, it covers all the costs of managing and running a mutual fund scheme. Such costs include sales and marketing expenses, administration fees, distribution fees, fund manager’s fees, etc.
The expense ratio is calculated by evaluating a scheme’s total expense incurred and dividing this figure by an AMC’s total assets under management (AUM).
Mutual funds are the ideal investment choice under the following circumstances:
If someone wants to invest for a short- or long-term goal
If someone wants to build your wealth
If someone is looking for reasonable returns on investments
If someone believes ELSS returns are better even after LTCG and want to have less lock-in period.
ULIPs are the ideal investment choice under the following circumstances:
If someone is looking for a tax-saving investment under 10(10D)
If someone is seeking a life insurance policy
If someone wants to invest for a long-term horizon.
ULIP vs. mutual fund
The following table provides elaborates on mutual funds vs. unit-linked insurance plans:
The aforesaid table is shown for illustration and understanding purposes only. Investments in mutual funds relatively carry higher risks. There is no assurance or guarantee of minimum returns in mutual funds
Which is better? Mutual fund or ULIP?
The decision to invest in mutual funds or ULIPs solely lies with the investor. Before investing in any instrument, an investor should analyze their financial needs. The right investment option is one that aligns with the investor’s financial goals, risk profile, and investment duration. For instance, if investments needs to be liquid, one can consider investing in mutual funds as ULIPs have a minimum lock-in period of 5 years.
Of course, not all mutual funds are liquid, and tax saving mutual funds (ELSS funds) have a lock-in period of 3 years. On the other hand, if someone is looking for insurance as well as wealth creation, one can consider investing in ULIPs.
In a nutshell, the primary aim of ULIPs is to insure the investor’s life, while the primary goal of mutual funds is wealth creation. Choose wisely, happy investing!
The information given here is neither a complete disclosure of every material fact of Income-tax Act 1961 nor does it constitute tax or legal advice. Investors are requested to review the prospectus carefully and obtain expert professional advice with regard to specific legal, tax and financial implications of the investment/participation in the scheme
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