Investing in mutual funds and unit-linked insurance plans (ULIPs) are two of the most popular investments among individuals in India. Both investment avenues are capable of providing good returns. Previously, there were some differences in how the maturity proceeds of a ULIP and capital gains of an equity fund were taxed.
The Union Budget 2021-22 has proposed some amendments to bring a level playing field between equity mutual funds and ULIPs. Now, there is some parity in the way that these avenues are taxed. The maturity proceeds ULIPs which were previously tax-free, are now taxable in the hands of investors.
Before we decide which investment avenue is beneficial, let’s first understand what exactly these investment avenues offer for individuals/investors.
What exactly is a ULIP?
A ULIP is an investment product which combines insurance and investment. Since there is an insurance component in ULIP, the amount you pay towards purchasing a ULIP is essentially termed as ‘premium’. The premium is split into two components. The first component of the premium goes towards securing your life, and the second component is invested.
What is a mutual fund?
A mutual fund is a professionally pooled and managed investments from various individuals and entities with common investment objectives. It is utilised to purchase assets as per the investment mandate with the sole view of providing investors with optimum returns. Depending on the equity exposure, mutual funds are classified into debt funds, equity funds and hybrid funds.
ULIPs vs mutual funds: Where should you invest?
You need to note that the returns offered by a ULIP will be restricted as compared to mutual funds. This is simply because the entire amount you pay towards a ULIP is not invested as some of it goes towards availing a life cover. Since only some portion of the premium is not invested, the return you get on ULIP as an ‘investment’ is low.
If you are to earn higher returns, you have to invest in a mutual fund. All mutual fund plans are handled by a professional fund manager who is backed by a team of market analysts and experts to make investment decisions that benefit investors in the long run. Let’s analyse both ULIPs and mutual funds from various angles:
Lock-in period: Open-ended mutual funds come with no lock-in period while ULIPs require your money to be locked-in for a period of five years. If you are to save taxes with mutual funds, you could invest in an equity-linked savings scheme (ELSS). If you are looking for liquidity, then investing in mutual funds is the right option.
Taxing maturity proceeds: Until Budget 2021, the maturity proceeds of ULIPs were tax-free if the annual premium was less than 10% of the sum assured. The maturity proceeds are taxable if the annual premium of a ULIP is over Rs 2.5 lakh. The applicable tax rate is 10%. On the other hand, the long-term capital gains of an equity mutual fund are taxed at 10% only if they are above Rs 1 lakh a year. Given this, the tax advantage that ULIP once had is no longer available.
Applicable charges: Investing in ULIPs is costlier as compared to mutual funds. A ULIP comes with fund management charges, mortality charges, premium allocation charges, and policy administration charges. All these charges put together amount to a significant sum. On the other hand, mutual funds charge a nominal annual maintenance fee in the expense ratio. If you are to optimise the cost of investment, mutual funds are a better option.
Conclusion
The amendments made in the Union Budget 2021-22 have made ULIPs lose the tax advantage. The maturity proceeds are now taxable if the annual premium exceeds Rs 2.5 lakh. Instead of investing in a ULIP, one may consider investing in an ELSS and purchase term life insurance separately.
For any clarifications/feedback on the topic, please contact the writer at vineeth.nc@cleartax.in
Engineer by qualification, financial writer by choice. I am always open to learning new things.
