ULIP or Mutual Funds: What Should You Invest In?

ULIPs and mutual funds are diversified market-linked investment plans, but there exists a significant distinction between them. While ULIPs come with insurance cover, mutual funds are purely an investment vehicle. To gain a better understanding of these two investment vehicles, let us delve deeper.

ULIP

A unit-linked insurance plan or ULIP is a financial product that encapsulates two components: investment and insurance. Despite the insurance feature, a ULIP is generally treated as an investment product than an insurance plan because of its constant comparison with mutual funds. ULIP is a long-term investment plan.

The premium paid by the investors is allocated towards the following:

Insurance: This refers to the portion of the premium that is diverted to the life insurance cover. It is this component that attracts tax benefits.

Charges: The premium paid by the policyholder, besides being split into the investment and insurance components, is also utilised for certain charges, such as:

• Premium allocation charge
• Mortality charges
• Fund management charge
• Policy administration charge
• Partial withdrawal charge
• Fund switching charge
• Premium redirection charge
• Premium discontinuance charge

Investment: The remainder of the premium is utilised for investment in funds. Under ULIPs, the investors have the freedom to choose from equity, debt, liquid, and balanced options.

Mutual Funds

Mutual funds are financial products with investment as the whole and sole component. These are created by pooling money from several investors, which is invested into stocks, bonds, money market instruments, and other assets.

The portfolio of investments in a mutual fund is structured according to the objectives stated in its prospectus. Mutual funds are managed by professionals who are known as fund managers. They can be categorized into four broad categories:

1. Equity funds (stocks of companies traded on the stock exchange)
2. Fixed-income funds (bonds)
3. Money market funds (short-term debts from government, banks, or corporations)
4. Balanced or hybrid funds (both stocks and bonds)

ULIPs vs Mutual Funds: Which One Should You Go for?

So which of these - ULIPs vs mutual funds

• make for a better investment option? To eliminate the confusion, let us view them through the lens of the following parameters:

Insurance Cover

A ULIP provides the policyholder with a cover in the form of life insurance.

Mutual funds, on the contrary, are purely an investment product - they do not have a built-in insurance cover.

Choice of Investments

As mentioned earlier, a ULIP allows you to choose from equity, debt, liquid, and balanced fund options.

In mutual funds, the choice of funds is dependent on the objective of investment specified in its prospectus. You can opt for investment in stocks, bonds, short-term debt instruments, as well as a combination of both stocks and bonds, as in the case of hybrid funds.

Lock-In Period

A ULIP does not allow for withdrawals before the lapse of the lock-in period. A five-year lock-in period exists in the case of ULIP before which funds are not even available for partial withdrawal.

In direct contrast, mutual funds allow greater flexibility and make for a liquid investment scheme. You can withdraw funds anytime- partially or wholly.

However, an exception exists in the case of ELSS (Equity-linked Savings Scheme). These require a lock-in period of three years, and there can be no withdrawals or redemption during this tenure.

Tax Benefits

ULIPs have two tax benefits under the Income Tax Act:

• Deductions (up to INR 1.5 Lacks)on premiums paid under Section 80C
• Exemptions on maturity proceeds under Section 10(10)D

In the case of mutual funds, except ELSS, no other category is eligible for deduction (up to INR 1.5 Lakhs) under Section 80C of the Income Tax Act. However, as in equity funds, capital gains earned from ELSS are eligible for taxation.

Risk

A ULIP allows you to choose from a host of fund options that you can invest in that align with your risk appetite.

In mutual funds, the risk profile depends on the mutual fund scheme you opt for. Equity funds entail high risk, debt funds come with a lower risk, and balanced funds present moderate risks.

Loyalty Benefits

Policyholders get access to loyalty benefits in the form of allotment of additional units if they stay with the fund for long periods. This is to incentivise a longer investment duration to the ULIP holders.

Mutual funds do not offer any loyalty benefits to their investors.

Conclusion

As ULIPs and mutual funds vie for your investment, the choice between the two, in essence, boils down to your expectation concerning their performance, liquidity requirement, the tenure of investment, risk appetite, and tax implications, among other parameters.

If you prefer a long-term investment plan with insurance cover, tax benefits, loyalty benefits, and flexibility, ULIP is your go-to plan.

However, if you want a financial product that can offer better liquidity, lower charges, and higher returns-mutual funds are a better option. Mutual funds are subject to market volatility and capital gain taxes.

I'm 32 Years Old, Marketing Manager. I provides investment guidance in Mutual Funds & other investment options.