Making investment decisions just based on the tax advantage has never been a good idea.
With the re-introduction of long-term capital gains tax (LTCG) on equities in this year’s Budget, the debate on —ULIPs vs Mutual Funds¬¬— has entered a new chapter. As ULIPs continue to remain out of the ambit of LTCG tax, many investors might ponder over whether to shift from mutual funds to ULIPs. However, making investment decisions just based on the tax advantage has never been a good idea. Mutual funds still outscore ULIPs on several fronts and here’s why they are still the best investment mode to meet your life goals:
Higher liquidity: ULIPs have a lock-in period of 5 years whereas equity mutual funds, other than close-ended funds and ELSS, do not have any lock-in period. While ELSS has a lock-in period of just three years, it is the lowest for all tax saving vehicles, including ULIPs, qualifying for Section 80C deductions.
Lower investment cost: ‘Low-cost’ ULIPs are often claimed to match equity mutual funds in terms of expense ratio. However, the expense ratios of equity fund direct plans are lower than that of low cost ULIPs. In case of equity index mutual funds, it can be as low as 0.15% p.a. In addition to fund management charges, ULIPs levy other fees, such as premium allocation charge, policy administration charge, switching charge and partial withdrawal charge, though there have been caps imposed on these charges by the regulator in the last few years. But still, depending on the way you manage your ULIP investments, the total charges incurred in ULIPs may exceed the expense ratios of most regular equity funds.
Greater transparency: The disclosure norms of mutual funds are far more superior than ULIPs. That is because mutual fund houses make a lot of effort on communicating their investment style, portfolio composition, past performances and other fund management related information to investors. Mutual fund houses also regularly communicate on how they wish to deal with different market scenarios and their reasons. In case of ULIPs, other than stating the asset class composition of various fund options, insurance companies communicate little on investment objectives and fund management style. Try compare the brochures or other investor communication from mutual fund houses and insurance companies and you will find the difference. Moreover, mutual fund schemes get rated by multiple third party agencies on the basis of their past performance, portfolio volatility, risk-reward ratios, portfolio churning, etc. This helps investors in making independent fund selection decisions.
Higher life cover when combined with term policy: ULIPs can fail in meeting the basic objective of a buying a life insurance policy, i.e. to provide your dependents with an adequate replacement income in case of your untimely demise. Ideally, your life cover should be around 10-15 times of your annual income. So if you are earning Rs 10 lakh p.a., your life cover should range between Rs 1 – 1.5 crore. However, ULIPs usually cover around 10 times of your annual premium. Therefore, a person earning Rs 10 lakh in a year will have to pay an annual premium of Rs 10-15 lakh for getting himself adequately insured. Hence, we advise investors to keep insurance and investments separate by buying term insurance policies for getting adequate life cover and mutual funds for meeting their life goals. A 30-year old can easily get a life cover of Rs 1 crore by paying an annual term premium of just Rs 8,000 – 10,000.
Higher flexibility: On using the combo route of term-plus-mutual funds, you can always redeem an underperforming equity mutual fund for a better one without reducing your life cover. However, redeeming an under-performing ULIP will leave you without its insurance cover. Also, buying an insurance cover also becomes increasingly expensive with an advancing age. Hence, the only option available to you will be to shift to another fund option from the same insurance company, leaving your fund management risk the same.
While this year’s Budget has certainly introduced a tax-imparity between ULIPs and mutual funds, there will always be a regulatory risk as far as taxation is concerned. ULIPs too can be brought under LTCG taxation in future. Moreover, the LTCG tax would only be levied on LTCG gains of over Rs 1 lakh, thereby keeping a large number of retail investors out of its ambit.
