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“Should I invest in a mutual fund or in a unit-linked insurance plan (ULIP)? What is better for me?”
If you have this question in your mind, don’t worry - you are not the only one who has this doubt!
This article discusses the features of these two products and the relative attractiveness of them from an investor’s perspective.
This is a fundamental question that needs to be addressed first.
At the very basic level, mutual fund products are offered by asset management companies (although we refer to them simply as ‘mutual funds’), whereas ULIPs are offered by life insurance companies.
By their very nature, all life insurance products, including ULIPs, are designed to be for the ‘long term’, i.e. typically for 10–20–30 years or even longer (e.g. the whole of your life)! On the contrary, like any other investment, although it is advisable for mutual fund products to be held for the longer term, the products themselves are not structured to be longer term products.
Also, what is the definition of ‘long term’? Well, there is no single definition! In the context of mutual funds, anything held more than one year might be considered to be long term – certainly from a capital gains tax perspective. Whereas, the minimum tenure of any life insurance product itself is five years. Hence, in the context of ULIPs, anything shorter than five years will certainly not be considered as ‘long term’. In fact, life insurers typically consider 10-20-30 years as ‘long term’.
Also, by its very design, ULIPs include some life insurance protection – i.e. in case of death of the person, the product will pay the ‘sum assured’, which is typically much higher than the premiums paid. Whereas mutual funds do not include any life insurance protection benefit.
Considering these two fundamental differences, one would argue that mutual funds and ULIPs are two very different products and not really comparable. They are like apples and oranges!
Despite their fundamental differences, almost everyone compares the two products and is faced with the dilemma of which product to invest in!
Let us compare some other features of these two products. A summary of the compared features is set out in the table below:
| ULIPs | Mutual Funds | ||
|---|---|---|---|
| 1 | Income Tax Benefits | ||
| Section 80(C) - on premiums | Yes - if premium is <=10% of sum assured | Yes - but only on Equity Linked Savings Schemes (ELSS) | |
| Section 10(10D) - on maturity proceeds | Yes - if premium is <=10% of sum assured and in case of policies purchased after 1 February 2021, premiums in a year is less than Rs.2.5 lakhs | No - see below | |
| Short Term Capital Gains Tax? | Not applicable | Yes - at 15% of capital gains after 31 January 2018 | |
| Long Term Capital Gains Tax (LTCG)? | No | Yes - at 10% of capital gains after 31 January 2018 in excess of Rs. 1 lakhs p.a. | |
| 2 | Policy term | Minimum 5 years | No restrictions |
| 3 | Lock-in period | 5 years | No restrictions (except on ELSS - 3 years) |
| 4 | Fund Switches | Permitted with no STCG / LTCG implications | Permitted with STCG / LTCG implications |
| 5 | Mortality / other optional risk benefits | Included | Excluded |
| 6 | Limits on charges | ||
| Premium Allocation Charge | 12.5% of annual premium | No such explicit limit (overall limit through TER - see below) | |
| Fund Management Charge | 135 bps (or 1.35%) | No such explicit limit (overall limit through TER - see below) | |
| Guarantee Charge | 50 bps | Not applicable - guarantees are not permitted | |
| Policy Administration Charge | Rs. 500 per month | No such explicit limit (overall limit through TER - see below) | |
| Mortality / Other Risk Charges | As approved by the regulator | Not applicable - mortality / risk benefits not provided | |
| Surrender Charge / Exit Load | Allowed up to four years, varying between 20% of (annual premium or fund value) or Rs. 3,000 (maximum) in the first year, to 5% of (annual premium or fund value) or Rs. 1,000 (maximum) in the fourth year on policies with annual premium up to R.50,000. | Not applicable. Any exit load charged is required to be credited back to the mutual fund itself. | |
| 7 | Maximum reduction in yield (RIY) [computed excluding the impact of mortality / risk charges] | Varying between 4% (for 5 years) to 2.25% (for more than 5 years) | Not applicable |
| 8 | Maximum Total Expense Ratio (TER) | Not applicable | Varying between 2.25% on the first Rs.500 Crore of AUMs to 1.05% for AUMs above Rs.50,000 Crore on equity funds |
| 9 | Additional TER to encourage investment from tier 2 / tier 3 towns | Not applicable | 30bps (provided new inflows beyond the top 30 cities is at least 30% of new contributions or 15% of AUMs, whichever is higher) |
The table of comparison above may seem daunting! But the main differences in the two products are:
The ULIPs, being longer insurance products, currently enjoy tax benefits which are not available to mutual funds. Specifically, your investments in mutual funds are subjected to a long-term capital gains tax (LTCG) of 10% (plus surcharge and cess), whereas the maturity proceeds from a ULIPs (subjected to certain conditions on the amount and level of premiums paid) are tax free.
This means, even if both mutual funds and ULIPs provide a return of say 10% p.a. on your investments over the long term, you may end up getting a net of tax return of say 9% p.a. (i.e. 90% of 10%) through your mutual fund investment, whereas you will get the entire 10% p.a. through your ULIPs as they are tax free.
ULIPs are subjected to some stringent regulations on the maximum charges that can be levied by insurance companies. Apart from limits on the maximum charges, the regulator has also prescribed a maximum reduction in yield (RIY) on ULIPs. Essentially, this means if the funds underlying the ULIP products earn an investment return of X%, the policyholder / investor should not get an IRR of less than (X%-RIY), ignoring the impact of the mortality charges levied by the insurance companies.
For example, if the funds underlying a 20 years ULIP earns an investment return of 10% p.a. for the insurance company, the various charges ae structured in such a manner that you, as the policyholder will get a return on your investment of at least 7.75% p.a. (ignoring the impact of mortality charges).
A mutual fund product, on the other hand, has a limit prescribed by the regulator on the total expenses that can be charged to your account. This limit is set at 2.25% (ignoring the additional expenses of 0.3% that are permitted in certain circumstances) – which is identical to the RIY of 2.25% on longer term ULIPs!
Thus, ignoring the impact of mortality charges on ULIPs and additional expenses on mutual funds, the maximum charges permitted on the two products are identical.
However, although the limits on maximum charges / expenses might be identical between the two products, given that the charges / expenses actually levied by the insurance companies and mutual funds may be lower than the maximum, the IRRs that you are expected to get may be different across the two products.
The ideal way to compare the two products is to compare the projected amounts and IRRs that you may get in the long term by investing the same amount of money in both the products.
Given below are two examples of how the projected amounts and IRRs may differ between a mutual fund and a ULIP offered by two companies from the same group.
Illustrated fund values and customer IRRs in a ULIP vs. Mutual Fund
| Example 1 | ICICI Prudential Life | ICICI Prudential Mutual Fund | |||||
|---|---|---|---|---|---|---|---|
| Amount (Rs. lakhs) |
IRR | Amount (Rs. lakhs) |
IRR | IRR | IRR | ||
| ULIP | Mutual Fund | Mutual Fund + term insurance (Annual premium 1.2 per 1,000) | Mutual Fund (net of LTCG tax in excess of 1 lakh, at 11%) + term insurance (Annual premium 1.2 per 1,000) | ||||
| At the end of which year | |||||||
| 5 | 2.9 | 5.03% | 3.1 | 6.76% | 6.35% | 6.35% | |
| 10 | 7.1 | 6.21% | 7.3 | 6.76% | 6.55% | 6.20% | |
| 15 | 12.9 | 6.52% | 13.2 | 6.76% | 6.62% | 6.16% | |
| 20 | 21.1 | 6.66% | 21.3 | 6.76% | 6.66% | 6.19% | |
| 25 | 32.8 | 6.79% | 32.6 | 6.76% | 6.68% | 6.24% | |
| Example 2 | SBI Life | SBI Mutual Fund | |||||
|---|---|---|---|---|---|---|---|
| Amount (Rs. lakhs) |
IRR | Amount (Rs. lakhs) |
IRR | IRR | IRR | ||
| ULIP | Mutual Fund | Mutual Fund + term insurance (Annual premium 1.3 per 1,000) | Mutual Fund (net of LTCG tax in excess of 1 lakh, at 11%) + term insurance (Annual premium 1.3 per 1,000) | ||||
| At the end of which year | |||||||
| 5 | 2.8(g) | 3.22%(g) | 3.0 | 6.11% | 5.67% | 5.67% | |
| 10 | 6.6(g) | 5.00%(g) | 7.9 | 6.11% | 5.88% | 5.59% | |
| 15 | 12.0(g) | 5.67%(g) | 12.5 | 6.11% | 5.96% | 5.54% | |
| 20 | 19.3 | 5.92% | 19.7 | 6.11% | 6.00% | 5.57% | |
| 25 | 29.4 | 6.06% | 30.0 | 6.11% | 6.02% | 5.61% | |
Source: Benefit illustration, product specifications, TER as published on the websites
By comparing the illustrative amounts and IRRs between the ULIP and the mutual fund product offered, it can be observed that the IRRs on ULIPs are typically lower than those on mutual funds for a number of years. For example, the IRR (of 6.79%) on ULIP of ICICI Prudential Life exceeds that on the Long-Term Equity Fund offered by ICICI Prudential Mutual Fund (at 6.76%) only at year 25. Thus, it may seem that in this instance, the mutual fund product is better than the ULIP.
However, as we know, the ULIP offers life insurance benefits as well as attracts tax advantage over mutual funds. If we reflect an adjustment for each of these, the customer IRR (at 6.21%) on ULIP of ICICI Prudential Life may actually turn out to be higher than that on the Long-Term Equity Fund offered by ICICI Prudential Mutual Fund (at 6.20%) as early as the 10th year.
Similarly, in case of SBI Life Insurance and SBI Mutual Fund, once we consider the tax advantage and the mortality benefit offered in ULIPs, the IRR on ULIP may turn out to be higher than the Long-Term Equity Fund at the 15th year.
In conclusion, one may expect to generate a better return through ULIPs, after considering the tax benefits and the mortality benefit offered, but only if invested for a sufficiently long term – say 10-15 years. Over the shorter term, mutual funds may offer a better return than the ULIPs.
Of course, this is not the end of the story! What we have considered so far are only the projected / illustrative IRRs. In reality, the actual IRRs may be different than those projected for a number of reasons:
Given this, it is important to regularly monitor the changing circumstances in assessing the relative attractiveness of the two products.