Has LTCG tipped the balance in favour of Ulips?

In a toss-up between mutual funds and Ulips, the latter seems to be gaining the edge

The introduction of long-term capital gains (LTCG) tax on equities seems to be harsh for retail investors. But it also seems to have made unit-linked insurance plans a better option than mutual funds. The tax, which will be levied at the rate of 10 per cent if equities are sold after one year, will be imposed without any indexation benefit. The relief: long-term capital gains up to Rs 100,000 will be exempt. Since there is no LTCG tax on Ulips, many mutual fund investors would wonder if the former is a better option after this recent tweak in taxation. Here's a comparison of these two products across various parameters to help investors decide. 

Tax benefit: Investments in a Ulip are eligible for a tax deduction on his premiums up to Rs 150,000 each year under Section 80C of the Income Tax Act. Among mutual funds, only equity-linked saving schemes (ELSS) are eligible for this benefit. Both the death benefit and the maturity benefit paid out by a Ulip are completely tax-free under Section 10 (10 D). In the case of mutual funds withdrawals made before one year will be subject to short-term capital gains tax at 15 per cent, while withdrawals made after one year will be subject to the newly-introduced LTCG.

Costs and charges: The 2010 Ulip guidelines brought down the charges significantly. But even after this, Ulips continued to be more expensive. But the fourth generation of Ulips sold online have charges that compare with the expense ratios of direct plans. These  Ulips have low or zero fund allocation charge and policy administration charge. 

For an honest, apple-to-apple comparison, the mortality charge levied by a Ulip should not be considered, as this goes into offering a life cover to the policyholder. Insurers, on their part, are working on ways to reduce the impact of mortality charge. While some have introduced Ulips that pay back all the charges at the end of the term, their high pricing nullifies this benefit.

Returns: Mutual funds have given better returns than Ulips. The average large-cap fund of a Ulip has given a return of 15.51 per cent over the past one year, while the average large-cap mutual fund has given a return of 18.83 per cent over the same period. Similarly, over the five and 10-year tenures, mutual funds are outperformers. It is only when one extends the investment horizon to 15 years or more that Ulips begin to match the performance of mutual funds.

To bridge the performance gap in the initial years (which is a function of higher costs in Ulips), now there are online Ulips that have very low charges. Take into account the newly-introduced LTCG tax, and the difference in returns from the two narrows down considerably.

In mutual funds, there is the challenge of investors staying disciplined for an extended period. Ulips, on the other hand, by having an element of compulsion to them (at least in the initial years), lead to ‘forced savings’. The loyalty additions provided by insurers also helps investors achieve their targets.

Transparency: Both Ulips and mutual funds disclose their net asset values (NAVs). But the complexity in the way charges are levied is a major issue. Mutual funds have a fund management charge that is built into the NAV that is declared. There is also an exit load if any investor quits before completing a minimum investment tenure. These are the only two charges that mutual funds levy. In the case of Ulips, the charge structure is more complicated. First, they deduct a premium allocation charge from the premium that you pay. After this deduction, the remaining premium amount gets invested. Next, the fund management charge is levied as a percentage that is deducted before arriving at the NAV. Ulips also have sundry other charges such as policy administration charge, mortality charge, and other miscellaneous charges. What makes the charge structure of Ulips more complicated is the fact that some charges are deducted upfront from the premium while others are deducted from the NAV. Some charges are levied by deducting the allocated units, while some are deducted from the fund value itself.

A Ulip's investment portfolio is also kept under wraps. Only the percentage that is allocated to equities and debt is disclosed. In a mutual fund, the investor has complete knowledge of the sectors and even individual stocks his fund holds.

Liquidity and flexibility: In a Ulip, the investor makes a long-term commitment of 15-20 years. Such long-term investments are not supposed to be liquid. If easy access is provided to these funds, investors will withdraw money from them, thereby hampering the fund’s growth. To meet short-term requirements or contingency expenditures, investors must have a separate corpus that is invested in savings accounts or liquid funds. Even if an emergency arises, a policyholder cannot dip into his Ulip fund until the five-year lock-in period ends. In an ELSS fund, the lock-in period lasts for a shorter duration of three years. One point that investors in ELSS funds must remember is that if they have invested in such a fund through the systematic investment plan (SIP) mode, then the three-year lock-in applies to each SIP. In a Ulip, once the five-year period ends, his entire fund gets unlocked. He can withdraw the entire amount, barring the prescribed minimum balance.

The mutual fund investor can also switch from one fund, and even a fund house, to another, whenever he desires. In a Ulip, the policyholder is stuck with the same insurer until the end of his policy term. If he wishes to move to a new insurer, he will have to terminate his existing policy. However, he can move from one fund to another with the same insurer. 

What should you do? Ulips have evolved and become better with each revision. Their charges have come down drastically. Mutual funds are pure investments that cater to needs ranging from short-term to long-term while offering better liquidity. Ulips have emerged as an attractive mix for someone who wants to fulfil both his insurance and investment needs through the same product. New online Ulips may, in fact, be better products than mutual funds. They definitely deserve your attention.

The author is director–health, life and strategic initiatives, Coverfox.com