Investment
Experts say treating ULIPs like an investment is a wrong idea as while they may appear a lot like mutual funds, they are often mis-sold.

Ever since Finance Minister announced the imposition of a 10% Long Term Capital Gains (LTCG) tax on gains of over Rs 1 lakh made from equity mutual fund investments, the otherwise attractive mutual fund schemes seem to be losing their sheen.

The reaction to the announcement has not been positive. The biggest proof of this is the market’s free fall ever since the Budget was announced. In just three working days, nearly Rs 9.6 lakh crore was wiped off with the Sensex falling 2,164 points. Tuesday saw the Sensex and Nifty’s biggest intraday fall since August 2015.

Now with a 10% LTCG tax, Equity Linked Saving Schemes (ELSS) will not be tax-free anymore either. At this point, you might have started looking at other investments that are tax-free.

And what is the one tax-free investment instrument at this point? Unit Linked Insurance Plan (ULIPs), as they don’t attract the LTCG tax.

What are ULIPs?

ULIP is a combination of insurance and investment, where a large portion of the premium paid by the policyholder is invested in investments similar to mutual funds, and the rest goes towards insurance. The duration of the investment is the term of the policy, throughout which the policyholder keeps investing the amount.

Up until now, ULIPs competed with mutual funds as an investment instrument. But given the higher returns mutual funds offered when it was tax-free, it was preferred over ULIPs.

But now, with the USP of not having to pay LTCG tax, your insurance agents and advisors may begin to suggest ULIPs over mutual funds.

But are ULIPs a better investment option?

Many experts do not believe so, and say treating them like an investment is a wrong idea as while ULIPs may appear a lot like mutual funds, they are often mis-sold.

According to Balwant Jain, a certified financial planner, mutual funds are still an effective investment option and a lot more attractive.

“While it may be tax-free, ULIPs are complicated and have several charges, including mortality charges. Insurance agents might make them look very attractive now, but I would advise people to still invest in mutual funds. Despite the tax, mutual funds will still offer higher returns. Plus, the Finance Minister has given an exemption on returns of up to Rs 1 lakh,” he said.

Costs associated with ULIPs

ULIPs come with several charges such as premium allocation charges, fund management charges, policy administration charges and surrender charges.  For a policy held for over 10 years, the maximum reduction in yield — which is the maximum amount that is cut down due to these costs on your total returns — is 2.25%. This is as per IRDA regulations. Over and above this, a mortality charge is also levied.

For mutual funds, a similar cost is expense ratio. However, depending on the type of mutual fund scheme, expense ratios in equity funds can range from 1.5% to 3%.

According to market analyst Anil Walia, many have burnt their fingers with ULIPs in the past.

“The purpose of insurance is to get fixed interest component and maturity amount, while ULIPs is more market-driven. Hence an investor is always aligned with the market, which defeats the purpose of an insurance policy,” he said.

Balwant also echoes the sentiment and says that for insurance, people should go for a pure-play insurance product and for an investment need, always look at mutual fund products. Mixing the two – as is the case with ULIPs – may not always be the best idea.

Moreover, for an equity mutual fund scheme, there is always an option of selling off the investment in case it is underperforming. This, when replicated with selling your ULIP, would mean that you will have to forego your insurance cover as well. Also, when investing in a ULIP, your insurance cover is very small as a major chunk of the investment goes into equity. When combined with the several charges, ULIPs turn out to be an expensive investment option.

Another question that might pop up in the mind of investors is the performance of the markets. What truly made mutual funds attractive over the past few years has been the stellar performance of the markets. However, post the Budget, the markets have been in freefall, witnessing new lows.

So would that affect the returns on mutual funds?

Balwant says even if the Sensex falls down to 30,000, the annualized return rate will still be around 12-15%. “This doesn’t take into account dividend yield, which comes to around 1.5-2%. That makes the gross returns about 17%. So if you have an investment in a good fund and have been regularly monitoring it over the years, you would have earned returns of not less than 20%,” he adds.

Should one switch over to ULIPs?

So while taking into account the LTCG tax, it is important to analyze your investment decision in a holistic manner rather than only looking at the tax benefit. Experts say that investments, as a principle, should always be long-term. So when taking a decision, it is important to consider what your investment goals are, what the costs involved are, and the gross returns expected from the product.

Switching to ULIPs could be a knee-jerk reaction and a mistake in the long term, most experts say.