Are mutual funds or Unit Linked Insurance Plans (ULIPs) better? There has been much debate about this topic. Both offer the benefit of long-term wealth creation and market-linked returns. Over the past years, the performance of these two financial vehicles has fluctuated, given the market volatility and regulations.

In order to make a well-informed decision between the two avenues, it is necessary to have an in-depth understanding of what is ULIP and term insurance with mutual fund.

About ULIP

Simply put, a ULIP policy offers the benefit of insurance coverage as well as return on investment. Part of the premium amount is used to cover the risk of an unfortunate death. In an event of death within the policy term, your beneficiary will receive the pre-determined sum assured amount, which may be used to fulfill various financial obligations. The remainder of the premium is invested in fund options, with a goal of seeking returns. The performance of these funds is market-linked, which means that the ULIP returns will be based on market volatility and fluctuations.

Understanding term insurance and mutual funds

Mutual funds are an avenue, which involves investment in bonds, money market instruments, stocks, and other assets. Mutual fund units are generally purchased or redeemed based on the fund’s Net Asset Value (NAV). You may invest in mutual funds across various sectors in order to limit your exposure to risk. For example, if you have invested solely in the construction sector and the sector fails to perform, you will lose a great deal of money. However, if you diversify your holdings in various sectors, say construction, energy, and hospitality sectors, and if the construction sector does not perform, you lose just a fraction.

If you are looking to insure yourself against unforeseen circumstances, then a term plan is your best bet. It is a pure risk plan, as it does not offer any returns upon maturity.

ULIP or mutual fund+ term insurance: Making the right choice

A comparative analysis between the two options will help you make a well-informed decision. Following are six points highlighting the differentiating points between ULIP vs mutual fund.

  1. Purpose of investment

The most important question to ask yourself is what is your purpose of investing? Are you looking for a high insurance coverage or is your goal to earn high returns? If you do not have an existing insurance cover, you may opt for a term plan. Such a policy offers high sum assured amount at a relatively lower price. However, if you have an adequate insurance cover, you may opt for a ULIP as an add-on. Investing in a ULIP policy will offer returns along with the insurance benefit.

  • Liquidity

Before investing in any investment vehicle, it is necessary to ascertain the liquidity aspect. You should be able to liquidate the funds in an event of an emergency. Mutual funds offer a high level of liquidity. You may redeem your units at any time and the equivalent amount is at your disposal. ULIP policies, on the other hand, come with a minimum lock-in period of five years. Therefore, you are allowed to withdraw your money only once the lock-in period is completed.

  • Flexibility

Both mutual funds and ULIP policies gain positive points in terms of flexibility. Mutual funds allow you to switch between schemes within a fund house. This helps you to mitigate your losses from poor performing stocks to better ones. ULIP policies, too, offer a high degree of flexibility through the fund switch option. Insurance providers such as Bajaj Allianz Life, offer various fund options such as pure stock fund, equity index fund II, asset allocation fund, accelerator mid-cap fund II, equity growth fund II, bond fund, and liquid fund. You may make the switch based on the market performance, your investment goals, and risk appetite.

  • Enhanced coverage

The concept of riders, also known as add-ons, is not applicable to mutual funds. Term plans, however, offer such a benefit. You may customize your policy based on your present and future needs by opting for riders such as critical illness rider, disability rider, accidental death rider, and waiver of premium rider, among others.

ULIP plans have a much stronger case in this aspect as it offers a term rider along with the ones mentioned above. Therefore, the scope of coverage in case of ULIP plans is higher.

  • Long Term Capital Gains Tax

The Finance Minister, in the 2018 Budget, announced Long Term Capital Gains (LTCG) tax on equity and equity-oriented mutual funds. Investors, therefore, began looking out for investment vehicles that offer higher returns with no tax liabilities. In such a case, a ULIP scheme is a relatively better option as compared to mutual funds as the LTCG tax is not levied on ULIPs.

  • Income tax benefit

You may make a choice between ULIP vs mutual fund based on your tax liability. Under the mutual fund category, only Equity Linked Savings Scheme (ELSS) funds are eligible for tax exemption. You may claim up to INR 1.5 lakh under Section 80C of the Income Tax Act, 1961. Term policies, too, qualify for tax deduction under this Section. However, ULIP plans qualify for tax exemption not only under Section 80C but also under Section 10(10D). The death benefit amount payable to your nominee upon death is tax-free under this section.

The bottom line is that, separate investments in mutual funds and term plan help in achieving their individual objective. ULIP policies, however, strike the right balance between the two. Based on the above differentiating points, you may make a well-informed decision based on your financial goals.

By Chakraborty

Dr Chakrabarty is the Chief Innovation Officer of IntuiComp TeraScience. Earlier she was Assistant Professor of Delhi University, a QS ranked university in India. Before that she has held research positions in IIT Mumbai, IIT Chennai and IISc Bangalore. She holds 2 patents and over 20 research publications in her name which are highly cited. Her area of research is in smart technologies, integrated devices and communications. She also has a penchant for blogging and is an editor of Business Fundas.