Mutual Funds Vs ULIPS: Are ULIPs Better After LTCG on Equity?

The debate or the war – ULIP better than Mutual Funds had a new chapter when Budget 2018 has introduced Long Term Capital Gain Tax for Equity Funds. ULIPS being an insurance product remains tax-free on maturity. Now with this recent change, let’s see if the scale has bent towards ULIPS. Let’s critically evaluate Mutual Funds Vs ULIPS after Budget 2018.

Evening of 1 Feb 2018, after the budget speech, one of the prominent company in insurance started circulating the one-pager with clear message that ULIPs are better as they are still tax free. I hope very soon you will hear in media more of this pitch, trying to mis-sell innocent investors.

First of all, we need to see what were the reason equity MFs are a better product than ULIP? Then we will see the effect of imposing a 10% capital gain on equity mutual funds.

 The reasons which made Equity MFS better than ULIPs were/are:

• Returns Mutual Funds Vs ULIPS

The main reason ULIPs have low returns is many charges are deducted before making investments. 

The premiums are charged with mortality. The insurance element has its cost. The company charges you for undertaking the risk of your life. So they charge an annual cost which is part of your premium.

Expenses: The fund management expenses, administrative costs, brokerage (often very heavy and charged more in first few years and then it declines after 3-5 years) all are deducted from the premium you are paying.

This means:

Amount Invested in Fund under ULIP is = Premium that You Pay Minus (Mortality + Expenses)

Now, this amount is huge in first 1-5 years (ranges between 5 to 15%) and then decline to (2-5%) post 5^th year.

Whereas in MFs the expense ratio is very much in control. Due to the limitation set by SEBI & competition, the expense ratio rarely goes above 2.75%. Majority funds ration is below 2.5%.

In ULIPs the entire premium is not invested. Although ULIPs invest in similar kind of funds like Large-cap, Midcap Etc since the huge amount is deducted beforehand they fail to compete. The performance gap widens more when time increases.

So the point is if your Rs 100 becomes RS 85 before investments, how will it compete with Rs 97.5, when they are put in same asset class?

• Mutual Funds Vs ULIPS Cost

In MFs the NAV is the clarity of your amount you are making or going to get if you exit. Simply the NAV that you see on websites or newspaper can be multiplied by a number of units you hold and you can know your valuation. If there are exit load, you may deduct that and you can calculate your exit amount.

In ULIPs NAV is not the returns that you are going to get. As discussed earlier, ULIPs have an array of charges. These are policy administration charges, fund management charges & mortality charges. These are charged by UNITs being liquidated on monthly basis. Mortality charges will go up with an increase in age.

Expenses exist in MFs also, but NAV is net of all the expenses.

In ULIP NAV is funded NAV, then the company charges the expenses. So NAV is never a reflection of your returns in a ULIP product.

Can ULIPs make returns like MFs?

One can make returns in ULIP after first 5 years, but a huge gap has already been made by the expenses of first 5 years.

Clearly, first 5 years the company makes good money and that is why there are restrictions that you cannot move out of the products. But when these exit restrictions are lifted this is the time investor can make money. It’s your requirement now, not the insurance company as they have made the bulk of profits in first 5 years.

Why Term Plans?                 

ULIPS is a costly combination of Insurance & Investments.

That is the reason, pure term plan scale over ULIPs or any other plans like endowments or money back. The important thing is the cost of any insurance.

Term plans give you the benefit of high cover at low cost.

What happens when LTCG is applied on equity MFs?

Now equity mutual funds will face 10% capital gain on profits that you make. With the 4% Cess the returns in hand will further be less.

Suppose you get 15% returns on Rs 1 Lakh Investments, post paying the long-term capital gain the returns work out to be:

Mutual Funds Vs ULIPS @ 15% Returns

Clearly, the difference between returns is big. ULIPs cannot be accepted as equal if 10 % is paid as tax, that too considering that Capital Gain Tax is to be paid when one make gains over Rs 1 Lakh (per PAN/per Year)

Other Benefits of MFs over ULIPS

• ULIPs have a lock-in of 5 years. MFs (excluding ELSS or close-ended funds) do not have any lock-in period.
• You have the flexibility to change MF company or MF scheme when you feel like your investments are not as per what you envisaged or as per your goals. ULIPs are not that much flexible. You need to exit and buy another product.
• Other than the charges that we discussed above, in case of exit before maturity, one also has to pay surrender charges. These can be in the range of Rs 6000 in the first year to Rs 2000 in the 5^th No surrender charges after 5 years
• If a ULIP is surrendered in lock-in period the fund is moved to “discontinued policy fund” which earns interest equivalent to savings bank only. You can get your funds only after lock-in period is over.

Buyers do not look or are not made aware of these inflexibilities and charges due to exit.

What about Transparency?

MFs have better disclosures and transparent norms. MFs declare their portfolios every month. Despite SEBI allows the quarterly portfolio to be declared but mostly all MFs do it on monthly basis.

MFs declare daily NAVs too.

ULIPs disclosure norms are governed by IRDA. Many declare portfolio on a quarterly basis and few do not. That is why portfolio, NAVs and fund comparison is difficult to locate.

Even though you know the NAV, it is difficult to get a valuation as units keep on changing due to charges. ULIPs are difficult to understand.

Final Words,

Equity MFs still the first choice for accomplishing your long-term goals.

You should take care in future as insurance companies may aggressively use this point to derail you form your financial discipline path.

Hope I have cleared your doubts on the choice of Mutual Funds Vs ULIPS.

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