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Why are mutual funds better investment options than ULIPs?

The ongoing debate on ‘which out of mutual funds and ULIPs is a better bet’ is never-ending. The introduction of 10% LTCG (Long-Term Capital Gains) tax on gains of more than INR 1 Lakh subject to earnings from the sale of shares in this financial year 2018-19, has created unrest among long-term investors.

At present, 15% of the overall gains over INR 1 Lakh, made in one year from investments, is to be paid as the LTCG tax. This tax is only applicable in case of sale within one year of purchase of the shares. In other words, if shares are sold post one year of purchase with gains of over INR 1 Lakh, then no LTGC tax is applicable.

The LTGC tax is capped at 30% of the earnings, in case of short-term capital gains while at 20% of the earnings, in case of sale of unlisted shares.

Mutual funds are investment instruments that provide the investors with an option to invest in multiple shares at the same time by choosing a fund of their choice. The money allotted towards mutual funds is allocated carefully in multiple shares and is managed by the expert, professional fund managers.

Mutual funds were introduced in India in 1963 and are presently governed and regulated by regulated by SEBI (Securities and Exchange Board of India).

Mutual funds are investment options for individuals who wish to balance their earnings on investment and risk-factor involved. Investors have several types of mutual funds to choose from, depending on their risk-bearing capacity, expected tenure, principal amount available for investment, expected returns and future goals.

Unit Linked Investment Plans provide the investors with the dual-benefits of investment and insurance. The amount invested in a ULIP is divided into two parts. One part is invested in the fund(s) of the investors’ choice and the other part is invested towards the assurance of insurance coverage. The aggregate of all premiums collected by all the investors in a ULIP is carefully analyzed by the fund managers and invested in the various debt and equity funds to create wealth for the investors. The IRDA (Insurance Regulatory and Development Authority) of India regulates and governs all ULIP investments in India since its introduction in India.

The basic points of distinction for ULIPs vs Mutual Funds are listed and explained in pointers below-

1.            Overhead charges

Mutual funds carry charges for fund management, and exit load as well in case of early selling.

ULIP plans carry multiple charges ranging from administration charges, switching charges, surrender or discontinuance charges, premium allocation charges, fund management etc.

These overhead charges reduce the ultimate benefit derived from ULIPs. This makes mutual funds a better bet, as they do not carry multiple overhead charges like ULIPs.

2.            Gains

Only the amount left after deducting the insurance premium on investment is invested in the dedicated funds in ULIPs. Because ULIPs carry multiple overhead charges, the ultimate amount invested is lesser than what an investor can invest directly. Also, the amount invested is much lesser than the amount dedicated towards fundallotment for revenue generation.  Thus, the returns generated by investment in ULIPs are less in comparison to direct investment.

Keeping the 10% profit being taken away by a tax on LTCG, mutual funds are a better option for investment in line with the capital gains from the investment.

3.            Liquidity

Mutual fund investments have instruments which do not carry any lock-in period and can be encashed as and when the need arises. An example of such funds is open-ended mutual funds that allow the investors to liquidate their investment at any point in time.

Some mutual funds carry an exit load that the investors have to bear in case they wish to withdraw the invested amount before the stipulated tenure.

In ULIPs, there is a minimum of 5-years lock-in period, which means the investor does not have the option to withdraw or liquidate their investment during this period even if they are in dire need.

4.            Tax Saving Benefit

The most favorable option for investors who wish to generate the tax benefit from their investment is the Equity-Linked Savings Scheme (ELSS), which is a type of mutual fund investment instrument. The returns earned from ELSS are tax deductible and the amount invested in ELSS is tax-exempted under Section 80C of the Income Tax Act, 1961.

ULIP investments also offer tax benefits which are deductible under the 80C (life insurance) or 80CCC (pension) at the time of investment as well as at maturity. The upper limit for exemption is capped at INR 1, 50,000.

But if we consider the tenure, ELSS, which a type of mutual fund, has a lock-in period of only 3 years while ULIPs carry tenure of 5 years. Also, ELSS has historically-generated much better returns than ULIPs.

The above-mentioned pointers clearly explain that mutual funds have a much better option of investment than ULIPs. ULIP plans are seen to create more limitations for the investors in the following points-

•              No liquidity

•              Less amount invested towards wealth creation

•              High premium on insurance

•              Multiple overhead charges

•              Lesser return on investment

The aptest investment option a person who wishes to get insurance as well as create wealth alongside should invest in mutual funds and a good term plan to gain multiple benefits and maximize returns.

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