ELSS or ULIP? Almost every individual who is contemplating an investment in market-linked instruments must have thought about this puzzle at least once. And to search for the answer they might have to go through tomes of literature available on financial websites, which tend to confuse people with their conflicting views.
The article aims to help investors make an easy decision by bringing them an unbiased insight and information about what actually ULIP and ELSS (a type of mutual fund) are and how one should decide to go for such investments.
Table1. Comparison of ELSS and ULIP Features
|Concept||An Insurance cum Investment Product||A pure investment product|
|Objective||A product that gives leverage to enjoy investment benefits along with tax relief with life coverage.||A professionally managed fund that gives benefits from diversified equity investments.|
|Lock in period||5 years. Premium payments may be stopped but the ULIP cannot be surrendered before the lock-in period expires.||3-year lock-in (Minimum in the tax-saving investment product category)|
|Tax Implication||Investments exempted from taxation U/S 80C and returns exempted U/S 10(10D) provided life coverage is minimum 10 times of annual premium||Investments non-taxable U/S 80C and returns upto Rs. 1 lakh a year are exempted from tax under Long Term Capital Gains (LTCG) tax rule|
|Switching||Switching between funds such as Equity, Debt, Hybrid, Balanced, or money market funds etc. allowed. No of switches and switching charges vary from company to company||No switching allowed as the entire money is invested in equity and equity-related fund. Systematic transfer plan may be initiated after lock-in expires.|
|Charges||Capped to 2.25% for policies 10 years and above, and a maximum 3% for others||Fund management charges applicable depending upon the fund which is around 2% and this gets adjusted in the NAV of the scheme. Lower charges applicable in the case of direct plans.|
|Loyalty Additions||Loyalty additions applicable for staying invested through the policy term depending upon the policy terms and conditions.||No such loyalty additions applicable.|
|Transparency||Lacks fund transparency as to where the money is getting invested.||Transparent and full details available about stocks and quantum of specific stocks held by the fund.|
|Risk||High risk, capital and return not guaranteed but life coverage is guaranteed.||High risk, returns depend on the performance of the broader markets and fund manager.|
To begin with, both of the products are similar in facts that they invest in equity and investor can claim tax deduction benefits under section 80C but that’s where the similarities end! Before we compare the two we must know what these products are and the range of features investors must know about them before investing.
What is a ULIP?
Unit Linked Insurance Plans better known as ULIPs are products marketed and sold by various Insurance companies. The USP of ULIP is it provides the dual benefit of investment opportunity in equity markets along with Insurance coverage.
Basically, the quantum of premium paid is allocated in such a manner that a part of it goes into different funds for the purpose of investments offered to the investor and part of the premium paid is kept to cover the life of the investor. ULIPs offer death insurance benefit to the investor, i.e. if the investor expires during the tenure of the policy, the nominee gets the sum assured or the fund value whichever is higher.
For example, Mr Mehta takes up a ULIP policy from XYZ company and pays an annual premium of Rs. 50,000 for a policy term of 10 years. The company has offered him an insurance coverage of 10 times the regular annual premium paid, which means his sum assured is Rs. 5,00,000.
Scenario 1: Mr Mehta meets an accident after payment of 3 premiums.
In this case, though Mr Mehta paid just 3 premiums that add up to Rs. 1.5 lakh and the fund value on the date of the claim is Rs. 1.7 lakh his nominee would get Rs. 5,00,000 in the case of the unfortunate death of Mr Mehta. Since higher of the sum assured or fund value is paid to the nominee in the event of the death of the policyholder.
Scenario 2: Mr Mehta dies of a heart attack after paying 9 premiums.
In this case, the premium paid till the date of claim is Rs. 4,50,000, the fund value stands at Rs. 5,95,000. Though the life cover was for Rs. 5 lakh the nominee of the deceased is entitled to get higher of the sum assured or fund value. In this scenario, as the fund value is higher; the nominee gets the fund value i.e Rs. 5,95,000.
Scenario 3: What happens in the event of surrender or maturity?
In case the life assured surrenders the policy or withdraws it on maturity, the fund value as per the current market value is paid out. As it is a market-linked product that invests in equities, the returns are not guaranteed with ULIP investments.
Benefits of Investing in ULIP
- In a ULIP product, an individual enjoys tax benefit at the time of investments U/S 80C to the extent of the maximum tax-deductible value of Rs. 1.5 lakh; the returns are totally exempted from tax U/S 10(10D).
However, in order to get complete tax exemption the mandatory life coverage should be a minimum of 10 times the annual premium, or else the tax benefit stands at just 10% of sum assured u/s 80C and the Section 10(10D) benefit is not applicable.
- A ULIP investor can switch between funds such as Equity Fund, Debt Fund, Hybrid fund or Money market fund etc. This gives an individual the liberty to switch funds and time the markets in order to get rewarded as a result of market churning. Switching may come for a charge and the number of times you are allowed to switch is also dependant on individual policies.
- ULIPs come with a lock-in period of 5 years; hence no surrender is permitted during this tenure. Even if someone stops the premium payment or tries to surrender the policy, the payout is made only after completion of 5 years. Further, since the early termination of the policy adversely affects the returns, it is generally a 10-15 year long commitment.
- The direct ULIPs offered online are great options for investors in terms of convenience. And as far as the mortality charge is concerned it starts diminishing year on year premium payment, as the risk of the Insurance company starts decreasing with premium inflow.
Drawbacks of ULIPs
When ULIPs were first introduced in 1971, investors expected it to deliver high returns but that did not come to fruition due to numerous hidden charges involved. The problem of ULIP is various kinds of expenses charged which include policy allocation charges, policy admin charges, switching charges, redemption charges, fund management charges, mortality charges etc.
Though with the passage of a new bill and a resulting amendment made by the Insurance Regulatory, and Development Authority (IRDA) in 2010, these charges have been capped at a maximum of 2.25%. Allocation charge along with policy administration charge cannot exceed this capping. And the fund management charge cannot exceed 1.35%.
However, despite capping the upper limit, a good part of ULIP returns get consumed by these charges. Further, the investment-insurance mix strategy that ULIPs provide prevents the investor from doing a cost-benefit analysis either of the two components of the product.
What is ELSS?
Equity Linked Savings Scheme (ELSS) is a type of mutual fund that facilitates investment in equity markets and at the same time save taxes both on the investment upto Rs. 1.5 lakh under section 80C of the Income Tax Act, 1961.
Benefits of Investing in ELSS
- ELSS has great yield potential as the entire corpus is invested in equities or equity-related products. Historically, an ELSS scheme has delivered anything between 12-15% per annum returns on an average which is one of the highest in the category of tax saving investment products.
- You can start investing in ELSS through Systematic Investment Plan (SIPs) with as low as Rs. 500 per month. Further, SIPs helps in rupee cost averaging and hence protects an investor from the market volatility risk.
- ELSS comes with a lock-in period of three years, which is the shortest span for any tax-saving investment u/s 80C. Here it implies that each unit has a lock-in period of three years. If you go through the SIP route, then all periodic investments get locked in for 3 years from the date of investment. Each unit can be redeemed only on the completion of three years.
- Any investment in an ELSS fund is tax-free under section 80C maximum up to Rs.1.5 lakh in one year. In addition, returns in form of long-term capital gains upto Rs. 1 lakh are also exempted from tax. However, capital gains exceeding Rs. 1 lakh are taxable at 10%.
Drawbacks of ELSS Investment
- Despite high yield potential, being a market-linked product, the returns and capital
- investments are not guaranteed. Since returns of market-linked products can be volatile, ELSS is best suited for investors having moderate to high-risk appetite.
ELSS Investment Options
Investors are required to pick either a growth option or a dividend option while investing in ELSS.
Growth option: Under the growth option whatever interest, bonus, gains, and dividends the fund earns get re-invested into the scheme itself. This gets reflected in the NAV of the scheme, no interim payments whatsoever are made out of the fund holdings.
The investor gets the return only upon redeeming the fund after the 3-year lock-in period is over. The NAV of the growth option dividend option of the same scheme varies a lot. The NAV of the growth option is much higher than the dividend option as no payouts are made and the fund invests in itself to provide greater returns.
Dividend option: Dividend option in a scheme indicates that there would be intermediate payments to the investor in the form of dividends. The rate and time of payment though are not predetermined and it depends entirely on the fund performance.
Under the ELSS dividend option, there are two sub-options: Dividend Payout and Dividend Re-investment. In dividend pay-out, the investor receives dividends in form of cash pay-out but in the latter option, no cash is paid, instead, the dividends are re-invested and additional units are bought and credited to investor account.
ELSS vs ULIP: A Comparative Analysis
ELSS is good for investors looking for a relatively short term investment with high growth potential. As returns expected from equity markets are comparatively higher than that of other investment classes. But one should remember that a long term investor can only reap the maximum benefit of wealth creation through equity investments. You can take the SIP route and ride the market wave in order to get the best of both worlds – small investment amounts, lower volatility risk and large payouts.
ELSS Investors have easy access to funds and also can check the fund performance on a real-time basis. It is best suited for young individuals who are not dependent on investment income for livelihood. This way the investor can keep funds invested for a longer period of time which would eventually help in wealth creation in the long term.
On the other hand, the only ULIP advantage is the dual benefit of insurance coverage and market returns. You get a unique product that protects your plan in case of the policy holder’s unfortunate demise along with the wealth creation opportunity through market returns.
However, the return potential of ULIP as a product category is very limited due to the presence of numerous charges and high commissions of agents. While the 5-year returns of best ELSS funds have varied between 13-17%, ULIP could only provide 8-10% returns on a 5-year basis. Further, the lock-in period of ULIPs is much higher than the ELSS.
Conclusively it can be said that high embedded cost, difficulty in cost-benefit evaluation, lack of transparency and low liquidity are the reasons for the lacklustre performance of ULIPs.