ULIPS stands for Unit-Linked Insurance Plans which is a combination of insurance and investment where the policyholders can pay a premium monthly or annually. A small amount of the premium goes to secure life insurance and the rest of the money is invested. The goal from a ULIP is to provide wealth creation along with life cover where the insurance company puts a portion of your investment towards life insurance and rest into a fund that is based on equity or debt or both and matches with your long-term goals. There are fund managers in the insurance companies who manage the investments.
The investment in ULIPs is denoted as a unit and is represented by the value called Net Asset Value (NAV). In a ULIP, the amount of premium to be invested after deducting all charges and premium for risk cover are pooled together to form a fund. The value of funds at any time is equal to the number of units multiplied by the value of the unit at that time.
Speaking of advantages, first and foremost, with ULIPs you get a life cover coupled with investment. It offers security that a taxpayer’s family can fall back on in case of emergencies like the untimely death of the taxpayer, etc. Secondly, a premium paid towards a ULIP is eligible for a tax deduction under Section 80C. Moreover, the returns out of the policy on maturity are exempt from income tax. Thirdly, in ULIPS, money gets compounded. As a result, the net returns are generally more. This stands true even if someone wants to exit after the 5-year lock-in period in comparison to not having invested the amount at all and retaining it in a savings account or in an FD. Additionally, ULIPS are usually designed in a way that they allow you to switch your portfolio between debt and equity-based on your risk appetite as well as your knowledge of how the market is performing.
The returns from ULIPs are on the lower side. The reason being, ULIPs promise a fixed sum whether or not the investment plan makes money. In comparison, the returns from mutual funds vary depending on the risk factor. Equity mutual funds have the potential to offer higher returns, while debt mutual funds offer slightly lower returns.
ULIP essentially is an insurance product. Therefore, insurance companies define the lock-in period for such an investment before which the investment cannot be redeemed. ULIPs have a lock-in period ranging between three to five years, depending on the nature and structure of the investment scheme. Mutual funds generally have a lock-in period of one year, but in some cases, like ELSS, the lock-in period is three years.
ULIPs are highly sophisticated products which offer a mix of risk cover and investment. These have a less transparent structure concerning the underlying expenses and asset allocation. Mutual funds are relatively open about the fee charged and the holding in the portfolio.
Investment in ULIPs is eligible for Income Tax deduction under Section 80C of the Income Tax Act, 1961, i.e. you can claim tax deductions of up to Rs.1.5 lakh a year on your ULIPs investment. Whereas mutual funds offer a tax deduction only against investment in ELSS. Investing in any other mutual fund scheme will not provide tax deductions and redemption of are subject to taxation as per the applicable tax bracket.
Mutual funds offer the benefit of low costs and professional management. SEBI has capped the expense ratio on mutual funds to 1.05% while there is no such limit for ULIPs. The charges for ULIP schemes can go much higher than mutual funds.
ULIPs come with an in-built insurance plan that offers the sum assured to the family in case the policyholder dies within the term of the policy. However, in the case of mutual funds, there is no risk cover by way of insurance. You need to buy a separate insurance plan and pay an additional premium for the same if required.
Ideally, mutual funds are suitable when you have (a) a short-term or a medium-term investment horizon; (b) Have a term insurance plan already in place; (c) Want high liquidity; (d) Have a high or medium risk appetite.
Although, no one instrument is a clear winner, in my opinion, if you are a short-term or medium-term investor who simultaneously wants higher liquidity and has a high or medium risk appetite, mutual funds are a recommended option. However, if you are a long-term investor who wants life insurance coverage and have a moderate risk appetite, then ULIPs are more suitable for you.
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