by Animesh p
Published Tue, Apr 25th 2017, 18:26 | Finance
The Unit Linked Investment Plan (ULIP) v/s Mutual Fund debate is in the eye of the storm yet again. Everything that can be said already has been said. However, the rules or both the investment avenues have changed recently. Many of the changes directly affect the returns of the investor. Hence it is worthwhile to revisit the old debate for a fresh reassessment of the two investments and to understand as to which makes for a better investment.
Sales people who are hard selling a financial product will often tell you that ULIPs are the same as mutual funds except that they also insure you. While there are some superficial similarities between the two, the products are very distinct from each other. An investor should not go by the sales pitch but understand the differences to make the right investment choice.
The purpose
The primary raison d'etre of ULIPs is life insurance. The recent turf war between Insurance Regulatory and Development Authority (IRDA) and Securities and Exchange Board of India (SEBI) ended when the courts decreed that IRDA will keep control over ULIPs, reinforcing that it is an insurance product.
Till now we had ULIPs minus any insurance cover. However, now it has been made mandatory for all ULIPs to provide at least mortality cover or health cover except for pension and annuity products. IRDA circular states that at any given time the annual health cover should not be less than 105% of the entire premiums paid. Investments with insurance provide a value added product for customers, whereas, mutual funds are primarily investment vehicles.
Returns
Mutual Funds, which depend on the stock market, do not offer any guaranteed returns. With the changed regulation, every ULIP pension or annuity product must present a minimum guaranteed return of 4.5 % per year or as mentioned by IRDA periodically on the date of maturation. Other ULIP products still do not offer guaranteed returns.
Investment horizon
Mutual funds are essentially short to medium term products (6 months upto 3 years or more). The liquidity that these products offer is valuable for investors. Equity Linked Saving Scheme (ELSS) are the only ULIP with a 3-year lock in. ULIPs, in contrast, are positioned as long-term products. IRDA has increased the lock in period of ULIPs. As per the new Insurance Regulatory and Development Authority (IRDA) guidelines, insurers will now have to increase the lock-in period for ULIPs from three to five years which means that during this period there would be no residuary payments on lapsed, surrendered or discontinued policies - and agent commission will be spread out. A top-up on insurance premiums will now be treated as a single premium, meaning that every top-up that one makes will have to have an additional insurance cover backing it up as well.
Expenses
In mutual fund investments, expenses charged for various activities like fund management, sales and marketing, administration among others are subject to some upper limits prescribed by the Securities and Exchange Board of India (SEBI). For example equity-oriented funds can charge their investors a maximum of 2.5% per annum on a recurring basis for all their expenses. All front end charges, which were used as commissions for the brokers, have been removed in Mutual Funds, ensuring that the money you invest goes directly towards churning out returns.
Insurance companies have had a free hand in levying expenses on their ULIP products in the past with no upper limits prescribed by the regulator, i.e. the IRDA. Each insurer structures their cost level as well as structure independently. Some insurers recover most of the cost in the first three premium payments, while some spread the costs over a longer period.
Under the new regulations, the maximum charge on a Ulip can be 4% (compared with 2.5% in a mutual fund) at the end of the fifth year, which makes it difficult for the insurance company to load costs in the first few years as is done now. This will cut down the huge brokerages earned by insurance agents and will hopefully provide the investor more transparency
Tax benefits
Till now, Ulip Nav investments qualified for deductions under Section 80C of the Income Tax Act. Maturity proceeds from ULIPs are tax free.
On the other hand with mutual funds, only investments in equity-linked savings schemes (ELSS) are eligible for Section 80C benefits. In case of equity-oriented funds if the investments are held for a period over 12 months, the gains are tax free; conversely investments sold within a 12-month period attract short-term capital gains tax @ 10%.
Similarly, debt-oriented funds attract long-term capital gains tax @ 10%, while a short-term capital gain is taxed at the investor's marginal tax rate.
Source:- http://bit.ly/2c3PV1y