ULIP or ELSS – which investment product is the right choice for me? From beginners to seasoned investors, almost everyone is confused when it comes to choosing between ULIP and ELSS. As tax-saving instruments, both these investment products are often clubbed together. However, they are two different products created for achieving different objectives.
Here, in this guide, we compare ULIP and ELSS, listing out the features, pros and cons of each, so that you can make a smart investment decision.
What is an ELSS?
The Equity Linked Savings Scheme or ELSS, in short, is a diversified equity-oriented mutual fund. Just like all equity mutual funds, the ELSS invests in the stock market, choosing shares of companies with varying market capitalizations.
ELSS investments come with a mandatory lock-in period of three years. It’s not possible to withdraw the funds invested in the scheme before the end of the lock-in period. An investor can claim tax deduction up to Rs. 1,50,000 per fiscal year, for investments made in an ELSS scheme.
What is ULIP?
The Unit Linked Insurance Plan (ULIP) is an insurance product. However, unlike traditional insurance policies, ULIPs offer the double benefits of insurance cum investment. One part of the premium is reserved for the life cover. The rest is invested in investment products as per the choice of the investor.
Investors can choose to invest in equity, debts, balanced, or hybrid funds based on his/her risk appetites. The investor can switch the investments from debt to equity and vice versa, based on his/her investment objectives. ULIPs have a lock-in period of five years. Just like ELSS, ULIPs offer tax exemptions up to Rs. 1,50,000 under Section 80C of the Income Tax Act.
Now, let's make a side-by-side comparison of both these popular investment products.
1.Product Type and Objective
ULIPs are an insurance product that also happens to offer investment opportunities. Hence it's provided by insurance companies. Investors can choose their preferred fund type – debt, equity, hybrid, or money market funds based on their investment objectives and risk tolerances. The minimum sum assured from a ULIP plan is ten times the premium paid. This is reduced to seven times if the entry age of the investor is more than 45 years.
ELSS, on the other hand, is a type of mutual fund. Hence, it is offered by AMC (Asset Management Companies or mutual fund houses). ELSS are pure investment schemes and do not provide any insurance.
Both ULIPs and ELSS are eligible for tax deductions on investments up to Rs. 1.5 lakhs under Section 80C of the old income tax regime. Now, let's take a look at the taxation of gains.
If you surrender a ULIP plan before maturity, any tax deductions claimed on the premiums paid are reversed, and you have to pay tax accordingly. The maturity amount is tax-free on the death of the policyholder, during the policy term.
If the premium paid is more than 10% of the minimum sum assured, then the maturity benefits received from the plan are added to the taxable income of the investor. The investor has to pay taxes as per his/her income tax slab. However, if the premiums paid is 10% more than the minimum sum assured and the gains for a fiscal year exceed Rs. 1 lakh, TDS of 2% is deducted at source.
The gains from an ELSS policy are tax-free. This is because profits (investment + capital gains + maturity benefits) up to Rs. 1 lakh are tax-free. However, note that LTCG beyond Rs. 1 lakh is taxed at 10%.
Additional Reading: Lock-in period of Mutual Funds
3.Charges and Fees
ULIPs have an array of costs like premium allocation charge, agent commissions, initial expenses, renewal charges, mortality charges, fund switching charge, policy administration charge, fund management fee, and more.
However, note that almost 60% of these charges are only for the first 1 – 2 years of investment. The fees are reduced after 3 – 4 years. So, to compensate for the expenses and earn higher returns, investors have to stay invested for a long time – around 10 to 15 years.
ELSS policies have only one charge – the expense ratio (also known as the fund management fee). The expense ratio is generally 3% and is deducted from the NAV and is not charged separately.
4.Fund Lock-in Period
ULIPs have a lock-in period of five years. While you cannot withdraw the amount before five years, you can discontinue the premiums, if the situation arises. In such cases, a discontinuance penalty is levied. The remaining amount is then moved to a discontinuation fund.
The lock-in period for an ELSS plan is three years. You cannot withdraw your funds before the completion of three years.
While technically, you can withdraw your funds from both the ULIP and ELSS after the end of the lock-in period, it's highly recommended that you stay invested to earn better returns.
The ideal investment horizon for:
10 – 15 years
7 – 10 years
6.Fund Switching Flexibility
In a ULIP, you can switch or change the ratio of the invested amount among various funds – debt, equity, or hybrid. This gives you the flexibility to adjust your investments to suit your different investment goals and objectives.
If you're young and open to risks, you can opt for equity funds to enjoy higher returns. As you age and your risk tolerance decreases, you can switch to debt funds to enjoy stability. Also, you can change your investments to debt when the market is low and switch back to equities when the markets pick up. However, note that you may be allowed only a certain number of free switches in a year. Beyond this limit, you will be charged with a switching fee.
In ELSS, there is no option to switch funds. It’s fixed for the entire tenure. ELSS plans offer the dividend option, where you receive regular payouts.
Pros and Cons of ULIPs
Tax benefits under Section 80C for the premiums and under Section 10D for the returns.
Easily switch between funds to adjust your investment portfolio based on your investment objectives and risk levels.
Even if you stop paying the premiums before the five-year lock-in period, your policy is not terminated. The funds accumulated are moved to a discontinuation fund, and you can generate returns on it.
ULIPs are a long-term commitment, around 10 – 15 years.
It comes with an array of charges. However, remember that the costs diminish the longer you stay invested in the product. Also, the IRDA (Insurance Regulatory Development Authority) has capped the allocation and policy administration charges to a maximum of 2.25%. The fund management charge cannot be more than 1.35%.
Pros and Cons of ELSS
The yield potential of ELSS schemes is high – around 12 to 15% per annum. It's one of the highest-earning tax-saving investments.
Starting an ELSS plan is quite simple. You can get started with just Rs. 500 per month as a SIP.
It has the shortest lock-in period of all tax-saving instruments under Section 80C.
Investments in ELSS are tax-free under Section 80C and the long-term capital gains up to Rs. 1 lakh are tax-exempted. However, note that LTCG beyond Rs. 1 lakh is taxed at 10%.
Though it has the potential to generate high returns, returns are not guaranteed. Just like all other equity-oriented mutual funds, the returns are market-linked.
Quick Comparison Table of ULIPs vs ELSS
|Mandatory Lock-in Period||Five years||Three years|
|Ideal Investment Period||10 – 15 years||7 – 10 years|
|Objective||Insurance + Investment||Purely investment|
|Tax Benefits||Tax deductions on premiums under Section 80C. Gains on the survival of the policyholder are taxable.||Tax deductions on investments under Section 80C. Gains beyond Rs. 1 lakh are taxable at 10%.|
|Applicable Charges||Multiple charges||Only the expense ratio|
|Ideal for||Ideal for investors who seek the dual benefits of insurance cum investment||Investors with moderate to high-risk appetite|
Additional Reading:What Is a Mutual Fund? How to Invest in a Mutual Fund?
Which is the better option? ULIP or ELSS?
Note that both ELSS and ULIPs are different investment products serving different objectives. If you are investing to save tax and can tolerate market exposure of the funds invested, then ELSS is the better choice. On the other hand, if you are primarily investing to enjoy life coverage along with wealth generation, then the ULIP is the better choice.
Make sure to do your research, consider your investment goals and risk profile and choose the right tax-saving option between ELSS and ULIPs.