If you plan to Invest in unit-linked insurance policies (ULIPs), merely for their tax-free maturity proceeds, you need to give it a double thought. Budget 2021 prohibits the exemption to ULIPs if the Investor’s annual premiums exceed Rs. 2.5 Lakhs. This will be applicable to ULIPs bought after February 1, 2021.
To elaborate, this means ULIPs will be treated as Capital Asset and profits on such plans will now be taxable as Capital gains. This would be 15% short-term capital gains tax (STCG) and 10% Long-term capital gains tax (LTCG).
The only major reason few Investors are investing in ULIPs has been discarded and this gives Mutual Funds an upper hand over ULIPs. Also because of Mutual Fund’s higher returns over the past years.
Now, let us dig deep into how Investing in Mutual Funds than ULIPs can attract more returns!!!
What exactly are ULIPs and Mutual Funds?
ULIPs are mix of Insurance along with Investment. A portion of your investment goes towards life insurance and remaining portion towards Investment. It is not a sheer Investment product so returns are also less than Mutual Funds.
On the Contrary, Mutual Funds are pure Investment products with sole purpose of generating returns. Investors can have mutual fund SIPs going on and take a term insurance plan separately which can result in higher benefits.
Why Mutual Funds are better than ULIPs?
When the Government announced its Union Budget 2018, there was a big debate on whether ULIPs had once again become attractive? The budget had imposed 10% tax on Long-term capital gains above Rs. 1 lakh on equity Funds. However, there was no Tax on ULIPs then.
The only factor that attracted few of the Investors to Invest in ULIPs has been disregarded in Budget 2021. There were many other factors which investors neglected or were not aware which made mutual funds a better investment option. To better address this point; let us consider key parameters to compare and evaluate both of the Investment products.
Various Charges in case of ULIPs and Mutual Funds.
As we can see there are ton of charges while investing in ULIPs and there can be few more hidden charges as well. On the contrary, in case of mutual funds there straight-forward two charges. Out of them one charge is discarded if you be invested till the maturity.
Profitability/Return in case of ULIPs and Mutual Funds.
In case of ULIPs, in first 5 years, substantial portion of your premiums goes towards costs and charges. Average returns are almost dragged to 6-7% post charges. That is why even in good market condition, it takes 8-10 years for ULIPs to breakeven. One needs to stay invested for almost 20-25 years without switching or restructuring their portfolio to get a decent return from ULIPs.
However, in case of Mutual Funds, average returns trailing in the market is almost 12-13% after charges. You can easily rebalance and restructure your portfolio to gain extra 5-6% returns without any major charges.
Mutual Funds are the best fit for your personal financial plan. The entire concept of combining insurance and mutual funds into one product is against the grain of Financial Planning.
Liquidity Factor in case of ULIPs and Mutual Funds.
If you are doing a SIP on diversified Equity Mutual funds then these funds are liquid from Day-1 itself. You can redeem these funds at any point of time and get the funds into your bank account latest by T+3 day.
However, ULIPs have a lock-in period of 5 years. You cannot completely redeem your Investment before this fixed period. Although, you can partially withdraw after 3 years but this will include penalty charges.
No proper risk covered in ULIPs Insurance Plan.
ULIPs have the advantage of Life insurance being associated with them. However, maximum Life insurance is limited to 20 times of the annual premium. Hence, if your annual premium is 50 thousand, you will get a maximum cover of only 10Lakhs and there will be mortality charges covered from your premium.
Instead of completing your insurance requirements from a ULIP, a term insurance is a better, simpler and cheaper option. And along with this you can simultaneously continue your mutual Fund SIPs.
Transparency and Disclosure Levels in Mutual Funds and ULIPs.
While ULIPs are required to disclose their NAVs on a daily basis, there are a lot of grey areas. Firstly, the portfolio disclosures are not as transparent and comprehensive as in the case of Mutual Funds. Secondly, the loading is very high in ULIPs and the exact break-up loading is not available.
In case of Mutual Funds, portfolio disclosures and analytics are of the highest level. Also, the Expense-ratio is mentioned clearly for investors to understand.
CONCLUSION: What should you do?
After Budget 2021, the only major factor of Tax-benefit that attracted few of the Investors has been discarded and those investors also might as well switch to Mutual Funds.
Every professional Financial advisor/planner will guide you to keep your Investments and Insurance separate and ULIPs just do the opposite. Therefore, it highly recommended for Investors to Invest their hard earned money in Mutual Funds which has benefits of Higher Returns, less charges, more flexibility, more liquid, complete transparency, etc.
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