Unit Link Insurance Plans vs Mutual Funds

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Often Mutual Funds are confused with another investment option Unit Linked Insurance Plan (ULIP). In this article we try to clarify all the questions around Mutual Funds vs ULIP.

What is a Mutual Fund?

To know about mutual funds, you can read here.

What is a ULIP?

ULIP is a wonderful hybrid of insurance and investment. It is essentially a combination of insurance and an investment vehicle. A portion of the premium paid by the policyholder is utilized to provide insurance coverage to the policyholder and the remaining portion is invested in equity and debt instruments. The aggregate premiums collected by the insurance company providing such plans are pooled and invested in varying proportions of debt and equity securities in a similar manner to mutual funds.

Each policyholder has the option to select a personalized investment mix based on his/her investment needs and risk appetite. Like mutual funds, each policyholder’s Unit-Linked Insurance Plan holds a certain number of fund units, each of which has a net asset value (NAV) that is declared on a daily basis.

Difference between ULIPs and MF:

Basis
ULIP
MF
Objective
ULIP provides an insurance cover along with a return from investment.
Mutual fund is pure investment instrument.
Premium utilization
A portion of the premium paid by the policyholder is utilized to provide insurance coverage to the policyholder and the remaining portion is invested in equity and debt instruments.
Example: Suppose, you pay Rs. 1 Lakh towards ULIP Scheme. In this, Rs. 10 thousand may be considered as premium towards insurance and Rs. 90 thousand would be invested in funds similar to mutual funds.
Entire amount put in Mutual Funds is invested either in Debt or in Equity. There is no insurance or risk cover component involved in Mutual Funds.
Example: Suppose, you pay Rs. 1 lakh towards Mutual Fund, whole amount gets invested in debt or equity as per the asset allocation of the Fund.
Lock-in Period
Insurance policies always have a lock-in period. Since ULIP is an insurance scheme, the investor cannot sell before the lock-in period of 3-5 years, it can vary from scheme to scheme.
Mutual funds do not have any lock-in period. Only certain mutual funds schemes, which are closed ended have a lock-in period.
Tax Benefit
ULIPs allow you tax deductions under Section 80C of the Income Tax Act. This means that if you invest upto Rs. 1.5 lakh in ULIP, you can avail tax deduction on the entire amount.
Under mutual funds, tax saving benefit is available only under Equity based schemes or ELSS schemes (You can read about ELSS here).
Further, long term capital gain and dividend income from equity based mutual funds is also exempt.
Charges:
ULIP charges a premium allocation charge, administration charge and maintenance fee for managing the fund. If you invest in ULIP, you also have to pay the insurance premium along with.  The Fund Management Charges for the ULIPs, however, are lower than Mutual Funds, 1.35% and 2.5% respectively.
The mutual fund charges a maintenance fee for managing your money and an exit fee i.e. a penalty for selling units soon after you invest in the fund.
Risk and Return
Modern ULIP Schemes are offering competitive returns similar to Mutual Funds. However, the fact that certain percentage of amount contributed towards ULIP is charged as insurance premium and returns are earned on remaining amount of investment, average return will be lower than a mutual fund with similar asset allocation.
Mutual funds with same asset allocation to a ULIP will result in better return because of 100% amount being invested and no deduction towards insurance premium.
Liquidity
ULIPs have a lock-in period as stated above. However, modern ULIPs are providing liquidity by giving the option of loan against ULIP investments. This has made the ULIPs more attractive
Mutual funds are listed on stock exchange which makes them highly liquid.

  Conclusion: Who should buy what?

There is no one-fit-for-all answer to this question. An investor shall perform an analysis between the following two options:

  1. Buying a term insurance separately and mutual funds separately
  2. Buying a hybrid ULIP consisting of Insurance as well as investment
Mutual Funds are more beneficial for some. The decision is solely based on the investor’s risk profile and the time period for which he/she wants to invest. If the investor has a low risk profile and wants to invest for a shorter time horizon, say 3 – 5 years, the investor should not go in for a ULIP or equity mutual funds. If the investor has a higher risk appetite and wants to go in for a long term investment, ULIP and equity based mutual funds should be considered. Whether it is for retirement or education, if a ULIP is availed till maturity, it is beneficial.  It gives you the dual benefit of savings and protection, all in a single plan. Finally, there is a difference between the objectives of an insurance scheme and investment scheme. Insurance scheme should be bought to provide a cover to your family whereas investment schemes should be bought to earn high returns. Even if you buy a ULIP, you should go in for a term insurance as the cover amount is very low in a ULIP as compared to a term insurance.
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Author:
Akanksha Goel | LinkedIn