ULIP vs. mutual funds - Understanding the difference

If you want to increase your wealth, one of the most popular options available to you is mutual funds. However, with so many types of mutual fund schemes in the market, you may be wondering which one is more suitable for you. And like many investors, you may be looking for an option that gives you an opportunity to increase your wealth while also helping you secure your financial future.

Enter Unit-linked Insurance Plans (ULIP). Both ULIP and mutual funds are great investment options for different types of investors. Let’s look at them one by one before entering the ULIP vs. mutual fund debate and finding which one is more suitable for you.

• Table of contents

1. What are ULIPs?
2. What is a mutual fund?
3. ULIP and mutual fund: what are the similarities and differences between them?

What are ULIPs?

A ULIP, short for Unit-linked Insurance Plan, is an investment plan that offers the combination of insurance and investment in equity, debt, or hybrid (equity and debt) instruments. A part of the premium pays for the life insurance cover and the rest is invested into equity, debt, or hybrid investment instruments for wealth creation.

What is a mutual fund?

A mutual fund is a type of investment scheme where an Asset Management Company (AMC) pools money from many investors to invest in equity or debt securities to create wealth. Most mutual funds have one or more fund managers assigned to manage the funds and to buy and sell securities to enhance the return potential for the investor based on the objectives of the mutual fund.

ULIP and mutual fund: what are the similarities and differences between them?

Many investors like to carry out a little ULIP vs. mutual fund comparative exercise to find out which one is more suitable for them.

Let’s see the similarities first – both mutual funds and ULIPs offer investors the opportunity to create wealth. But the similarities end there.

Moving on, here are 5 key differences between ULIPs and mutual funds:

1. Investment objective

A mutual fund offers the opportunity to create wealth as it is a purely investment product whereas a ULIP is an insurance and investment product packed into one. It is important to note here that, for all practical purposes, ULIP is considered a primarily insurance product that offers the added advantage of investing in the market for wealth creation.

2. Lock-in period

Being an insurance product at heart, all ULIPs have a mandatory lock-in period of at least 5 years. In contrast, the lock-in period for mutual funds depends on the type of scheme chosen by the investor.

Close-ended mutual fund: The investor can only subscribe during the New Fund Offer (NFO) and wait until the lock-in period is over to redeem the investment in a close-ended fund.

Open-ended mutual fund: The investors can redeem the investment at any time if they have invested in an open-ended scheme, subject to exit load.

Equity-linked saving schemes (ELSS): In mutual fund schemes, it is only for Equity-linked Saving Schemes (ELSS) that a 3-year lock-in period is enforced. The investor can redeem their investment after 3 years.

3. Taxation

This is one of the important points that helps investors decide which one of the ULIP and mutual fund schemes is a suitable investment product for them.

Taxation on ULIPs

Investments in ULIP offer tax benefits under Section 10DD, 80C and 80CCC of the Income Tax Act. Let’s understand them in detail.

Tax Benefit on ULIP Premium: Investors can claim a total deduction of Rs. 1.5 lakh per annum on the premium paid towards ULIP subject to conditions under Section 80C and Section 80CCC of the Income Tax Act. For ULIPs issued after 1st April 2012, they are only eligible for the deduction if the premium amount is less than 10% of the death sum assured chosen for the plan. The deduction is capped at 10% of death sum assured for higher premium amounts.

Tax Benefits on Payout of Life Cover to Nominee: In the case of death of the policyholder, the life cover amount paid to the nominee is exempt from tax.

Capital gains from ULIP plans are taxed under the Short-term Capital Gains (STCG) category at 20% if the period of holding is less than or equal to 12 months. The capital gains are taxed under the Long-term Capital Gains (LTCG) category at 12.5% on gains above Rs. 1.25 lakh if the period of holding is more than 12 months.

Taxation on mutual funds

Investors can claim a tax deduction on investments made towards ELSS under Section 80C of the Income Tax Act. There are no tax deduction benefits on any other kind of mutual fund schemes. The capital gains from mutual fund investments are taxed based on whether they are debt or equity funds and how long they are held by the investor.

4. Risk level

Being primarily an insurance product, a ULIP offers risk cover and financial stability to the family in case of the sudden demise of the policyholder. Mutual funds offer no risk cover to the investor or their family. However, an important thing to note here is that both ULIP and mutual funds invest in the market and the returns depend on the market movement.

5. Return on investment

ULIPs offer a life cover because of the insurance component being built into the investment. The actual returns depend on the performance of the investment in equity and debt securities. The returns from mutual fund investments also depend on the performance of the investment in prevailing market conditions.

Feature	ULIPs	Mutual Funds
Investment Objective	Insurance & Investment (Primarily Insurance)	Purely Investment
Lock-in Period	Minimum 5 years	Varies by scheme (e.g., Close-ended, Open-ended, ELSS)
Taxation	Tax benefits under Sections 10DD, 80C, 80CCC; Tax on capital gains (STCG/LTCG)	Tax deduction on ELSS under Section 80C; Tax on capital gains (depends on debt/equity and holding period)
Risk Level	Offers life insurance cover; Market risk	No life insurance cover; Market risk
Return on Investment	Depends on insurance & investment performance	Depends on market performance

Factors to consider before choosing between ULIP and Mutual Fund

The choice between a ULIP and a mutual fund depends on your financial goals, risk tolerance, and investment horizon. Both options have unique features that cater to different needs.

ULIPs:

If your priority is life insurance coverage with an investment element, ULIPs may be suitable. They provide financial protection for your family in unforeseen circumstances but come with a mandatory 5-year lock-in period and potentially higher charges that could affect returns.

Mutual funds:

For those focused solely on wealth creation without needing life insurance, mutual funds are generally more suitable. They offer diverse investment options and tend to have lower expense ratios compared to ULIPs.

Key factors to consider:

Investment objective: Choose ULIPs for life insurance with investment or mutual funds for pure investment needs.

Lock-in period: Understand the impact of the 5-year lock-in period in ULIPs on your liquidity.

Taxation: Compare tax benefits based on your tax bracket and investment duration.

Risk tolerance: Select the option that aligns with your comfort level regarding risk.

Investment horizon: Consider long-term goals and the growth potential of each option.

Charges and fees: Review expense ratios and other associated costs for both.

Conclusion

In conclusion, there is no clear winner when it comes to the ULIP vs mutual fund debate. Both ULIP and mutual funds have their pros and cons. You can choose one or both depending on your investment portfolio. We recommend that you discuss it with your financial advisor before making any investment decisions.

FAQs:

What is the primary difference between ULIPs and mutual funds?

ULIPs (Unit Linked Insurance Plans) combine insurance and investment, while mutual funds solely focus on investment, providing distinct financial objectives.

Which option is more suitable for long-term wealth creation?

Mutual funds are often preferred for pure investment purposes, offering more flexibility and potentially lower costs.

Is it good to invest in ULIP?

ULIPs can be a suitable option for individuals seeking both life insurance coverage and investment growth potential. They provide investment flexibility, tax benefits, and suit long-term horizons but involve various charges and market risks. Assess financial goals, risk appetite, and fees carefully, and consult a financial advisor before deciding on ULIPs.

What are the tax benefits of ULIP?

Taxation on ULIPs provides benefits under Sections 80C, 80CCC, and 10(10D) of the Income Tax Act. Premiums up to Rs 1.5 lakh annually are deductible if conditions are met. Death payouts are tax-free. Capital gains are taxed at 15% for short-term (≤12 months) and 10% for long-term (>12 months, above Rs 1 lakh).

Which is a more flexible investment – ULIP vs mutual fund?

Mutual funds offer more flexibility than ULIPs in fund selection, investment strategies, and liquidity. They provide diverse options, easy scheme switching, and higher accessibility. ULIPs, while less flexible, combine life insurance with investment benefits, appealing to those seeking dual-purpose financial solutions.

What is the return of ULIP in 5 years?

ULIP returns over five years vary based on fund performance, market conditions, charges, and investment strategies. Equity funds offer higher growth but involve more risk. Returns are not guaranteed and depend on underlying investments. Use ULIP calculators or consult financial advisors to estimate returns and align them with your goals and risk tolerance.

Is ULIP tax free after 5 years?

ULIP maturity proceeds are not automatically tax-free after 5 years. To qualify under Section 10(10D), the life cover must be at least 10 times the annual premium throughout the policy term. The 5-year lock-in restricts withdrawals but doesn’t ensure tax exemptions.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully. This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.