Ulip or Equity Mutual Funds: Is the debate back after the new tax rules?

The major advantage that Ulips have enjoyed since 2018 was that irrespective of premium they were tax-exempt on maturity.

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The new tax rule on high ticket unit linked plans as against MFs has impacted only one aspect of the comparison.

Since the introduction of unit-linked insurance plans (Ulips), a comparison has always been made with equity mutual funds. Ulips are often referred to as almost similar to mutual funds (MF) wrapped with insurance cover. The tax rules introduced in 2018 favoured Ulips in terms of taxation. The gains above Rs 1 lakh made in equity-oriented MFs are subject to tax at 10 per cent of long term capital gains while Ulips remained out of the tax net. However, the Budget 2021 has proposed tax on gains made in Ulips with an annual premium of Rs 2.5 lakh.

“Going forward, if the annual premium of new Ulip investment is more than Rs 2.5 lakh, the return will no longer be tax-exempt. The tax exemption shall be available under Section 10(10D) only for maturity proceeds of the Ulip having annual premium up to Rs. 2.5 lakh. In case of Ulip policies taken on or after February 1, 2021, and having annual premium more than Rs 2.5 lakh the return on maturity shall be treated as Capital Gain and charged accordingly under section 112A,” says Rajesh Bansal, MD, Midas FinServe Pvt Ltd, a financial services firm.

Is the debate about Ulip or Equity MF back after the new tax rules as the tax edge that Ulips enjoyed earlier will now be lost especially on high-premium policies. Not exactly as making a choice between Ulips and MF need not be entirely based on the tax factor. “The new tax rule on high ticket unit-linked plans as against MFs has impacted only one aspect of the comparison. Customers who prefer Ulip are likely to continue doing so due to their unique advantages such as lower fund management charges, loyalty benefits over the long term, the flexibility of asset allocation, along with life cover which future proofs financial goals,” says Samit Upadhyay, CFO & Head of Products, Tata AIA Life Insurance

But, the structure of Ulips may not work for all investors. “The major advantage that Ulips have enjoyed since 2018 was that irrespective of premium they were tax-exempt on maturity. Ulip allocate a share of the investment amount towards insurance and this portion varies with the age of the investor, typically the portion increases with age. Ulip also comes in with a lock-in period of 5 years. As a result, from an investor’s perspective, Ulip becomes less attractive than equity MFs as they have a higher lock-in period, force investors to allocate money towards insurance, while no longer providing the tax benefits ( on premium above Rs 2.5 lakh per annum),” says Santosh Joseph, Founder and CEO, Germinate Investor Services LLP. The death benefit, in all insurance policies, however, remains tax-exempt in the hands of the nominee.

For those looking to save through Ulips, there could be several different options to customize the plan suiting one’s needs. “I think it is incorrect to compare Ulip and equity Mutual Funds as they both satisfy a different need. A Ulip provides a financial safety net to the insured person by providing the necessary life insurance cover while helping to build wealth over the long-term through a variety of investments. In addition, there are certain Ulips which offer critical illness benefits and health riders. With these riders, a Ulip becomes a single plan offering a range of benefits, and hence it is a powerful asset in terms of the financial security it extends to the investor, which an MF doesn’t offer. Moreover, child- Ulip offer a waiver of premium benefit in case of the unfortunate demise or disability of the policyholder,” informs Karthik Raman, CMO & Head – Products, Ageas Federal Life Insurance.

If one is able to manage insurance and investment needs separately, sticking to a combo of term insurance plan and mutual funds can work well. But if one wants to keep both insurance and investment under one plan, Ulips may fit the bill. “It’s generally better to keep insurance and investments separate instead of using a single product to address both needs. Standalone term insurance has better benefits of higher coverage for a much smaller premium compared to a Ulip. Equity MFs can be used for long term wealth creation needs. Ulips do offer a benefit in that the non-insurance part of the investment can be switched based on the market conditions. For example, an investor can switch from equity allocation to debt allocation based on the market without incurring the exit loads and the tax implication. It’s highly unlikely that typical retail investors would be able to time the markets to take advantage of such a provision. Hence for the majority of the investors, equity MFs and standalone term insurance are best suited to address their insurance and investment needs,” suggests Joseph.

For those who are not comfortable in managing protection and investment needs separately, Ulips with its add-on features can be used to plan the long term needs. Anyone buying ulips needs to be aware of the fact that its a long term product and hence any exit mid-way will prove costly. “Ulips and Mutual Funds, both help customers in fulfilling their financial and wealth creation goals. Ulip gives customers the additional benefit of life cover which provides a more comprehensive financial planning option Ulip a single instrument. Ulip also provides an opportunity for policyholders to diversify their portfolio by investing across hybrid and debt funds in addition to equity funds. To summarize, both the products will keep on attracting customers based on their features and benefits and both will thrive in the large demographic opportunity that India offers,” says Aneesh Khanna, EVP – Product, HDFC Life Insurance.

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