Choosing investments that align with one’s financial goals while also providing tax benefits is a critical part of investment planning. Two options that often come into consideration are ulip vs elss. Both vehicles offer enticing tax benefits under Section 80C of the Income Tax Act. These similar tax benefits can leave investors confused about which option to choose for achieving their financial goals while maximising their tax savings. But there is much more to these powerful instruments than just tax benefits, and there are quite a few differences between the two. Understanding these differences thus becomes important for making informed investment decisions.
ELSS or Equity Linked Savings Scheme is a kind of mutual fund that invests mainly in equity instruments like shares, while ULIP or Unit-Linked Insurance Plan is a combination of insurance and investment. Besides the tax benefits, both vehicles offer potentially high returns, professional fund management and diversification. So let’s take a deep dive and find out what separates ELSS and ULIP, so you can choose the most suitable and effective option for yourself.
Difference Between ULIP and ELSS Mutual Fund
Let’s take a look at seven key aspects that can help us highlight the difference between ulip and elss:
Investment Objective
Just like any other equity fund, the main purpose of investing in ELSS is capital appreciation. ELSS offers market-linked returns, which can help investors amass a significant fortune over the long term. Although ELSS has a short lock-in period of three years, it doesn’t imply that investors should only remain invested for that duration. The lock-in period primarily serves tax-saving purposes, but staying invested beyond this period can enable investors to take advantage of the growth of their investments and maximise returns. Equity products such as ELSS tend to generally perform better in the long term rather than short because there is a high potential to ride out market fluctuations and volatility while taking advantage of compounding returns over time.
ULIPs are hybrid financial products that offer both insurance coverage and investment opportunities, so in addition to providing protection, they also have a role to play in tax and investment planning. ULIPs are more suited to investors with a dual objective of financial protection and wealth accumulation. The ULIP premium is divided into two components. While one component goes towards providing you with insurance coverage, the other is allocated for investments in various funds such as equity, debt, or a combination of both, depending on your risk appetite and financial goals. The returns here are also market-linked.
Tax Benefits
Before we compare how ULIP and ELSS are taxed differently, let’s see where they’re similar. Both ULIP and ELSS give tax benefits of up to Rs. 1.5 lakh under Section 80C of the Income Tax Act. The difference in tax treatment arises when it comes to redemption.
ELSS units can be redeemed after the lock-in period of three years. For equity funds, the short-term capital gains (STCG) tax is only applicable for investments held for less than one year, so only the long-term capital gains (LTCG) tax is applicable for ELSS. A flat 10% tax is charged on LTCG exceeding Rs. 1 lakh in a financial year.
In the case of ULIP, the government recently (on February 1, 2021) made some changes regarding ULIP taxation. Earlier, ULIPs offered tax-free withdrawals under Section 10 (10D) of the Income Tax Act upon maturity, but under IT rule 8AD, ULIPs are free from tax only if the premium does not exceed Rs. 2.5 lakh in a financial year. If the premium paid does exceed the given limit, capital gains tax is applicable on the income earned. Thus, if one invests Rs. 2.5 lakh in a year in ULIP, no tax will be charged upon maturity, which gives it an edge over ELSS investments.
Charges
When it comes to charges and fees, ULIP tends to be more expensive compared to ELSS mutual funds. This is because there are many types of charges associated with a ULIP, such as
- Premium allocation charges – This refers to the percentage of the premium that the insurance company deducts before investing the remaining amount into the funds you choose.
- Policy administration charges – These charges are fixed and cover administrative costs. It is deducted every month by cancelling a number of units from your investment.
- Fund manager charges – These charges are similar to mutual funds asset management fees (between 0.5% to 2.5%)
- Mortality charges – Also charged on a monthly basis, these charges cover the death benefit.
- Other charges – Include switching charges, surrender charges, commissions, and renewal charges. All in all, these charges vary from one ULIP to another.
ELSS on the other hand, charges a more manageable and straightforward fee. Overall, their expense ratio is lower compared to ULIP, and it covers the fund management expenses, administrative costs, and other operational expenses.
Liquidity
ELSS mutual funds have a short lock-in period of three years. After this period, investors can redeem their units however they like without incurring any penalty. This period of three years is the lowest lock-in period among all tax-saving investment options under Section 80C of the Income Tax Act, so it provides investors with higher flexibility and liquidity compared to not just ULIPs, but also other tax-saving instruments such as Public Provident Fund (PPF), National Savings Certificate (NSC), and Tax-saving Fixed Deposits (FDs).
ULIPs come with a relatively longer lock-in period of five years. During this period you can surrender your policy, but that would also mean letting go of the life coverage it provides. You still won’t be able to withdraw your investment immediately and will have to wait before the lock-in period is completed. A surrender charge will also be incurred which can affect your overall returns, so it might be a better move to switch to a different fund within the ULIP rather than surrendering.
Thus, due to the shorter lock-in period, ELSS offers investors higher liquidity than ULIP.
Risk and Returns
Both ULIP and ELSS offer market-linked returns, so a certain degree of risk is associated with them. ELSS mutual funds are pure investment products, where the fund manager invests at least 65% of the fund’s assets in equity and equity-related instruments. Due to this allocation, ELSS have the potential to offer high returns over a long period. Naturally, it also means that ELSS mutual funds come with a higher level of risk. That’s why one should invest in ELSS or any other equity product with a long-term perspective.
ULIPs are not a pure investment product, as they combine investment with insurance. As far as ULIP’s returns are concerned, first, you need to understand that only a part of the premium you pay is invested in the fund of your choice. This is because a portion of your premium goes towards securing your family’s future in case of any unfortunate event. This is a direct contrast to ELSS mutual funds, where all your money is invested in an equity fund. Therefore, there are more chances of generating higher returns in ELSS mutual funds due to their exclusive focus on equity investments.
Secondly, ULIPs allow you to choose the type of fund you want to invest in. You have the option to choose from various types of funds, such as equity funds, debt funds, and balanced funds. Equity funds mainly invest in stocks and aim for higher returns over the long term but also come with higher risk. Debt funds mainly invest in fixed-income instruments such as government securities and bonds and aim for more stable returns with lower risk. Balanced or Hybrid funds, as the name suggests, strike a balance between equity and debt investments and offer a mix of growth potential and stability. The type of fund you choose depends on your risk tolerance and financial goals.
Moreover, ULIPs allow you to switch between funds, which is a big advantage over ELSS. In ELSS, you can only invest in equity instruments, but in ULIP, you are allowed to switch as per your investment strategy and the overall market conditions. While ULIPs may not offer as high returns, they offer flexibility.
Lock-in Period
One of the main points investors discuss in the ULIP vs ELSS debate is the lock-in period. ULIPs have a lock in period of five years. One can surrender the policy during this period, but that can result in a surrender charge, which will negatively impact the returns.
ELSS mutual funds, on the other hand, have a shorter lock-in period of three years, which is the shortest among tax-saving investment options available under Section 80C of the Income Tax Act. After the three-year period expires, one can easily redeem their investments. However, remember that an investment in an ELSS mutual fund works best with a long-term view, as it allows you to not only take full advantage of the power of compounding but also to navigate through market ups and downs effectively.
Expense Ratio
The expense ratio is the percentage of a mutual fund’s assets used to cover its operating costs and administrative fees. This fee is deducted before the returns are distributed to investors. Different ELSS mutual funds have different expense ratios. Before you decide on an ELSS mutual fund, always compare their expense ratios. Lower ratios mean fewer fees deducted from your investment returns.
As stated before, ULIPs have many charges associated with them such as premium allocation charges, policy administration charges, fund manager charges, mortality charges, switching charges, surrender charges, commissions, and renewal charges. It’s not necessary that a ULIP will have all these charges, but the first four are generally always there. Overall, these charges make the cost of investing in ULIP higher than ELSS mutual funds.
Also Read: How to Claim Tax on Unit Linked Insurance Plan (ULIP)?
ELSS vs ULIP: Comparative Analysis
Here’s a table outlining the difference between ulip and elss mutual funds:
| Aspect | Unit-Linked Insurance Plan | Equity Linked Savings Scheme |
| Type of Product | Hybrid product that combines investment with life insurance. | A pure investment product. |
| Investment | Investors are allowed to choose from equity, debt, and hybrid funds. | Investment is done mainly in equity-related instruments (minimum 65%) |
| Switching | Switching between funds is allowed. | No switching is allowed. |
| Investment Objective | Suited for investors looking for capital appreciation and life coverage. | Suited for investors with the goal of wealth creation in the long term. |
| Tax Benefits | Offers Rs. 1.5 lakh tax benefits under Section 80C. If the annual premium paid is Rs. 2.5 lakh or less, the maturity amount is free of tax under Rule 8AD. | Also offers Rs. 1.5 lakh tax benefits under Section 80C. A 10% LTCG tax is applicable on gains above Rs. 1 lakh in a financial year. |
| Charges | Includes many charges such as premium allocation charges, mortality charges, and policy administration charges. | Includes expense ratio. |
| Liquidity | Not as liquid as ELSS mutual funds due to the longer lock-in period. | Higher liquidity compared to ULIPs. |
| Risk and Returns | Returns and risk associated vary based on the type of fund one chooses. | Potentially high market-linked returns, but a high degree of risk is also associated. |
| Lock-in Period | 5 years. | 3 years, the shortest among all tax-saving instruments. |
| Expense Ratio | Is higher compared to ELSS. | Lower than ULIPs. |
Investors should thoroughly understand the difference between ulip and elss mutual fund, and make sure their choice aligns with their financial goals, risk appetite, and investment horizon.
FAQs:
1. Is ULIP and ELSS the same?
No, ULIPs and ELSS mutual funds are different financial products. While ULIPs combine insurance and investment, ELSS mutual funds are purely an investment product that invests mainly in equity-related instruments (stocks).
2. Who Should Invest in ULIP or ELSS?
Investors with a high-risk tolerance and a long-term view who are seeking pure equity exposure, along with Section 80C tax deduction can look into ELSS as an option. Since ULIPs combine insurance with investment, it may be a better option for individuals looking to get that dual benefit along with 80C and 8AD tax benefits.
3. Is ULIP better than ELSS?
There are quite a few differences between ULIP and ELSS. We cannot say one is definitely better than the other, as each of them has its pros and cons. The choice between the two depends on how well it aligns with an investor’s unique financial situation, investment horizon, financial goals, and risk appetite.
4. Is ULIP a good investment?
ULIPs are a good investment for investors who want life insurance coverage along with investment opportunities while enjoying the tax benefits under Section 80C and Rule 8AD. Due to the variety of funds they offer, they are appealing to individuals with low, moderate, or high-risk tolerance.
5. Is ELSS a good investment?
ELSS is a great option for individuals with high-risk tolerance seeking to accumulate wealth in the long term while enjoying the tax benefits under Section 80C.
