After the imposition of LTCG tax on equity-oriented mutual funds, everyone seems to be in a dilemma – whether to go for mutual funds or ULIPs now? We are helping you compare the two and decide for yourself.
After the LTCG tax announcement in the Union Budget 2018, everyone seems to be in a dilemma – whether to go for mutual funds or ULIPs? Though ULIPs have emerged as a good alternative to mutual funds as a tax-free option, but taxability alone cannot be the parameter to decide on a good investment option. There are other parameters too which need to be considered by an investor before investing in any product. Here is an apple to apple comparison of both the investment options:
By now everyone is aware that ULIPs are a tax-free investment option and seem to be a better deal than mutual funds after the imposition of LTCG tax. However, ULIPs always had an edge over MFs as equity mutual funds, if held for less than a year, were taxed at 15% as short-term capital gains. But ULIPs being an insurance product were tax-free under sec 10(10d). Now that the LTCG tax will kick in from 1st April 2018, ULIPs will have a bigger advantage as they offer debt and liquid fund options to investors which comes under the fixed income space.
Let’s take a scenario where two individuals – Mr Nair and Mr Sharma – are looking for investment options. Mr Nair invests in ULIPs while Mr Sharma invests in mutual funds. A part of Mr Nair’s investment is taken every month as an insurance cover which will be compensated to Mr. Nair’s family in case of his demise. Whereas, Mr Sharma has to buy an insurance policy separately to get a life cover. Thus, ULIPs here provide you both investment and life cover whereas MFs are a pure investment option.
3. Additional Protection
Some ULIP products may offer riders or inbuilt benefits. Everyone has a reason to save and there might be a certain specific need which you want should meet upon your demise like your child’s education. Here, ULIPs pay a lump sum amount to your family in case of your untimely demise and take care of your family. The insurer continues paying the premium on your behalf providing regular income to your family for the remaining policy tenure till the time your dependent/child reaches the maturity.
4. Lock-in Period
Since ULIP is an insurance product, it has a lock-in period of 3-5 years depending on the product type. Thus, an investor cannot sell it before that time-period. Mutual funds do not have a lock-in period and can be bought and sold anytime. Only certain types of MFs have a lock-in period which are known as ‘closed fund’.
MFs charge you for managing your money and exit fee, whereas ULIPs charge you for the insurance premium, administration charge and charge for managing your funds. But do not be fooled as the Fund Management Charges for ULIPs can never be more than that of Mutual Funds. Charges for ULIPs are 1.5% and that for MFs are 2.5%. Also, IRDAI mandates that the total effective charges on ULIPs should not exceed 2.25%.
6. Risk Exposure
As ULIPs are insurance products, they are less risky. Mutual funds are riskier in nature. Equity-oriented mutual funds are riskier than hybrid ones and hybrid mutual funds are riskier than debt funds.
As ULIPs invest in low-risk products, hence, return on ULIPs is also low as they have to promise the sum assured irrespective of whether the plan makes money or not. Equity-oriented mutual funds give higher returns, being riskier than hybrid and debt mutual funds.
Mutual funds are more liquid as an investor can exit any time he wants. ULIPs have a five-year lock-in period, after which only partial withdrawals can be made. Although it is advisable to remain invested for a longer period of time as the returns will be higher and this generates the sense of responsibility in investors unlike the fickleness associated with mutual fund investors.
Investors should understand their risk profile and then decide on whether to opt for ULIPs or mutual funds. Investors with low-risk profile and investment capacity of 3 years must not opt for any of these options. Investors with higher-risk profile and longer investment horizon should go for ULIPs or equity-oriented mutual funds. Both the products should not be confused with each other. Investors looking for both investment and protection cover for their family should go for ULIPs and investors with a purpose of wealth creation should go for mutual funds.
(By Naval Goel, CEO and Founder of PolicyX.com)