The battle between Mutual Funds and ULIPs to attract more investors have been going on from some time now. With various benefits, Mutual funds seemed to have the edge over ULIPs. However, all this changed with the introduction of a tax on long-term capital gains (LTCG) from equity by 2018 Union Budget. Now, long-term capital gains from ULIPs are entirely tax-free whereas investors need to pay tax on capital gains from equity funds.
Let’s understand which of these two options is a better choice for you, after the introduction of LTCG on equity.
- How are Mutual Funds and ULIPs taxed?
Even before the introduction of the LTCG Tax on equity shares and equity-oriented mutual funds, ULIPs had an edge. As ULIP is an insurance product, the underlying capital gains were tax-free under Section 10(10D) of the Income Tax Act, 1961.
Short-term capital gains from mutual funds were taxable @15% whereas long-term capital gains were not taxable. But with the introduction of taxes on LTCG from equity, now the long-term capital gains in excess of Rs 1 lakh will be taxed at the rate of 10%. So, if the LTCG on the sale of equity funds is 1.30 lakhs, then the investor needs to pay a tax of Rs. 3,000 on the capital gains of Rs. 30,000. However, the LTCG from debt funds is still taxable at 20% with the benefit of indexation, which effectively reduces the tax liability to a minimal amount.
- Post-LTCG Tax: Mutual Funds vs ULIPs
The tax exemption available on ULIPs might be a significant factor when making an investment decision. But you should never make your investment decisions based solely on the tax benefits. You need to consider several other factors to arrive at a final decision.
Some of the crucial factors that need to be considered before making an investment decision are:
ULIPs come with a substantial front load structure coupled with risk cover. This reduces the amount which would be invested in the capital market. Consequently, the investor may end up with below-average returns.
In contrast, mutual funds don’t have entry loads and come with lean expense ratios. So, the entire amount is invested in the underlying assets. As a result, there are higher chances of you ending up with higher returns.
Mutual funds offer better flexibility than ULIPs. Except for tax-saving mutual funds (ELSS), they don’t have a lock-in period. You also have the option to pause a Systematic Investment Plan (SIP) or switch to another fund in case of poor performance.
ULIPs are multi-year commitments; you must pay the policy premium throughout the period. Missing even a single premium would cause the policy to lapse. Additionally, these have a lock-in period of 5 years, and this makes it relatively less flexible for short-term investors.
Mutual funds are more transparent in terms of their charges, and they are built into the NAV. For ULIPs, some charges are not built into the NAV but are levied by way of cancellation of units. The information regarding mutual funds is tracked by various agencies and you as an investor can look into various aspects related to your investment.
When you invest in mutual funds, you enjoy a significant degree of liquidity. It takes only a few minutes to liquidate your investments. The funds will reflect in your account on the same day (an exit load might be levied if you exit from the scheme before one year). In the case of ULIPs, you are stuck for five years and can not withdraw your money before completion of the lock-in period.
- Choice and ease of investment
There are several types of mutual funds that are available for you to choose from. You can quickly complete your KYC online and start investing in mutual funds. But in case of ULIPs, the process is lengthy. You need to fill several offline forms and go for medical tests to be eligible. Sometimes, they can also scrutinise your income tax returns to ascertain your eligibility for ULIPs.
There is no denying the tax benefits on ULIPs. However, mutual funds still have the edge over ULIPs when you consider several other parameters. So, weigh-in all the factors and only then make a final decision regarding where to invest your money.