With equity mutual funds coming under the ambit of taxation in the recent Budget 2018-19, insurance companies have made a strong case for selling ULIPs to investors. While a 10 per cent tax has been imposed on long term capital gains of equity mutual funds, ULIPs continue to remain tax free. Insurance agents have been dwelling on this tax disparity as part of their sales pitch. If this has got you thinking or confused whether to buy ULIPs or mutual funds, read on further to find out which one is a better product. Taxation alone is not a good enough parameter to judge a financial product. Let us compare ULIPs and mutual funds on the following other parameters:
Costs: Cost is a big factor when it comes to delivering superior returns over a longer investment horizon. ULIPs, a combination of insurance and investment, doesn’t have a simple cost structure like mutual funds. While they have fund management charges akin to mutual funds or maybe even lower in few plans, the insurance layer adds a host of charges. These include premium allocation charge, policy administration charge, mortality charges, surrender charges, etc. Each of the expenses reduces the investment amount and hence the final returns. Although insurance companies have reduced the various charges over the years, still most of the ULIP products cannot beat equity mutual funds in terms of costs.
Flexibility & Liquidity: Although equity investing is for the longer haul, an investor does not want to be stuck in a bad product. In case of an equity fund not performing well, an investor can exit a fund anytime by selling it or switching to another fund. In a ULIP, there is a compulsory lock-in period of 5 years. So, if an investor is not happy with the performance of the fund during that period, he cannot switch to another fund or redeem the fund. While he has the option to surrender the policy, he will have to pay additional charges plus he will not receive the money on surrender. It will be transferred to a discontinuance fund earning peanuts like in a savings bank account and will be given to the investor only after the completion of the 5-year tenure at the then prevailing value. Not only does he lose his insurance cover, he also incurs a loss as majority of the charges are levied in the initial 5 years eating into his investment.
Further, if an investor wants to make partial withdrawals, he can do so any time in a mutual fund through a systematic withdrawal plan or just plain partial one-time redemption. In a ULIP, partial withdrawals (after the lock-in period of 5 years) are subject to a lot of restrictions depending upon the value of the fund and the total premiums paid. It is important to note that any withdrawal from ULIP also proportionately reduces the insurance cover. Also, unlike a mutual fund where an investor can make additional investments to an existing fund (lumpsum or SIP), without any cost, a ULIP investor needs to pay mortality charges on fresh investment which are treated as single premium payment.
Returns: Equity mutual funds score over ULIPs when it comes to investment returns. We have analysed the returns of few mutual funds and ULIPs from the same financial institutions. Here is a comparison between mutual fund and ULIP schemes with similar themes of ICICI, HDFC, Aditya Birla Sun Life and Kotak Mahindra: The table above clearly shows that ULIP returns compared to their peer fund houses are lower in the range of 100-400 basis points. For e.g., in the past 5 years, Rs.1 lakh invested in ICICI focussed Bluechip Fund would have grown to Rs.2.2 lakhs while the same amount if invested in ICICI Pru Maximiser V would have grown to Rs.1.96 lakh. When extrapolated over 15 years, the gap in absolute returns can widen to about Rs.3 lakh.
Transparency: The structure of mutual fund portfolios is transparent and simple to understand. The fund management charges are built into the NAV and there is an exit load if the investor redeems before a minimum holding period. In contrast, Ulips are opaque with complex charges. Some of the charges like policy and mortality charges are not factored into the NAV but levied by cancellation of units. Further, mutual funds are widely researched, rated and tracked by various agencies. Investors can find out every month about their portfolios, sector allocations and individual stocks comprising the portfolio. While Ulips offer the same information, they are not tracked very widely and investors usually are clueless about the best performing Ulip funds.
Conclusion: Life insurance is a necessity and hence should be a long-term commitment. But many ULIP investors do not commit paying premiums for the long term. They usually choose to surrender or redeem the investment when they find out that ULIP is not performing well. However, they do not realise that while redeeming the investment, they lose the crucial life insurance cover.
Further, ULIPs are expensive and it is likely that the customer would end up under insured with a small cover. It is hence better to not mix insurance with investment needs as the former is about protection and the latter is about wealth creation. The best way to buy adequate insurance cover is opting for a pure term insurance plan which comes with cheaper premium, allows to buy a large cover and also qualifies tax benefit under S/80C.
Coming to investments, rather than looking at just the tax angle, investors should take investment decisions in a holistic manner. While considering a longer time horizon, an investor should look at his personal goals, costs involved, returns expectations, etc and then commit to a product. In this regard, equity mutual funds are a better bet compared to ULIPs.