ULIP vs ELSS: Which one is for you?
When it comes to investing your hard-earned money most of you look for avenues which promise the best returns. This is where the capital market holds attraction as it allows you to avail good returns which are inflation-adjusted to fulfil your financial goals. Besides the attraction of good returns, capital market instruments also gives you flexibility in managing your investments. Given these benefits, many of you invest in different types of investment avenues which are market-linked.
Capital Market is a portion of the financial system that usually deals with the equity market, stocks, bonds as well as other long-term investments.
Two of the most popular market-linked investment avenues are Unit Linked Insurance Plans (ULIPs) and Equity Linked Savings Schemes (ELSS). While ULIPs are offered by life insurance companies, ELSS schemes are mutual fund schemes which are offered by mutual fund houses. Both these avenues work in a similar manner wherein the money that you invest is invested in market-linked funds which give you market-linked returns. But does this similarity make ULIPs and ELSS same?
No, it does not. ULIPs and ELSS are completely different from one another even though they are both market-linked investment tools. Let’s understand how –
What are ULIPs?
ULIPs are a type of life insurance plan offered by life insurers. Under this plan, the premium that you pay is invested in a fund that you choose. There are different funds with different risk profiles and you can choose any fund as per your investment needs. The funds, in turn, invest their portfolio in different securities of the capital market. After you buy a ULIP, your invested premiums grow as per the performance of the market. In case of death during the policy tenure, you get higher of the sum assured or the fund value. If, on the other hand, you survive the policy tenure, you get the maturity benefit which is the fund value.
Salient features of ULIPs
ULIPs have the following salient features –
- They provide both market-linked returns as well as insurance cover
- You can withdraw from the policy partially after the first five years have been completed
- You can also change the investment funds whenever you want through the switching facility available under the policy
- Premiums can be paid at once, for a limited period or for the entire policy tenure
- You can also pay additional premiums through top-ups
- You can decide the amount of premium that you want to pay, the policy term and the investment tenure. The sum assured is decided based on your age and premium amount
- On maturity, you can choose to receive the maturity benefit in instalments over a period of 5 years
- Different types of ULIPs are available for different financial needs like child ULIPs, pension ULIPs, savings ULIPs, etc.
- The premium that you invest in ULIPs is allowed as a deduction under Section 80C of the Income Tax Act up to INR 1.5 lakhs
- The maturity or death benefit received is also allowed as a tax-free income. The full income is exempted from tax under Section 10 (10D)
What is ELSS?
ELSS schemes are mutual fund schemes which also invest in the capital market. They are equity-oriented funds wherein at least 65% of the fund portfolio is invested in equities. The objective of the scheme is to yield equity-oriented returns and also give a tax advantage.
Salient features of ELSS schemes
ELSS schemes have the following salient features –
- There is a lock-in period of 3 years from the date of investment. You cannot redeem your investment within this lock-in period
- The money invested in ELSS schemes is allowed as a deduction under Section 80C up to INR 1.5 lakhs
- You can invest in ELSS schemes through a lump sum investment or through regular monthly investments in the form of Systematic Investment Plans (SIPs)
- The returns that you earn are exempted from tax if they are up to INR 1 lakh per annum. For returns exceeding INR 1 lakh a flat tax of 10% if charged on the excess.
This basically means, if you redeem your investments in a particular financial year where the returns are upto INR 1 lakh, then you do not need to pay any tax. However, if your returns (i.e. capital gain over investment) is more than INR 1 lakh, in that particular year, then you need to pay 10% on the amount over INR 1 lakh.
For example, your investment amount is INR 5 lakhs and when you want to redeem the same, the amount is INR 6.5 lakhs. So, INR 1.5 lakhs is considered as “returns” and if you redeem the entire amount, then you would have to pay 10% of INR 50,000 (excess of INR 1 lakh).
However, if you redeem the amount is 2 financial years, i.e. INR 75000 of returns in 1 year and the remaining INR 75000 in the next, then you would not have to pay any taxes.
ULIPs vs ELSS – the tax perspective
Though ULIPs and ELSS are very different, the one thing that truly sets them apart is their individual tax implication. Let’s understand how –
- ULIPs vs ELSS – tax implication on investment
When it comes to investments, both ULIPs and ELSS schemes allow deduction under Section 80C. So, in both cases, your investment amount would be considered as a tax deduction U/C 80C upto INR 1.5 lakhs a year.
This is the primary reason why many investors choose these two investment options to reduce their tax outgoes.
- ULIPs vs ELSS – tax implication on returns
This is where the difference is marked. While ULIPs allow you completely tax-free returns, ELSS schemes don’t. As per the latest changes made in the Union Budget of 2018, returns exceeding INR 1 lakh would be taxed at 10% for equity-oriented investment schemes. Since ELSS schemes are equity-linked, if your returns are more than INR 1 lakh, you would have to pay tax on the returns exceeding INR 1 lakh. So, if you earn a return of INR 1.5 lakhs on your ULIP investments, no tax would be payable on it. However, the same return under ELSS schemes would result in a tax of INR 5000 (10% of INR 50,000).
This tax implication tilts the scales in favour of ULIPs.
- ULIPs vs ELSS – tax implication on partial withdrawals and surrenders
ULIPs allow partial withdrawals and surrenders after the first five years of the plan are over. These partial withdrawals and surrenders are also tax-free in your hands.
Under ELSS schemes, however, any partial withdrawal or surrender that you do is treated as redemption. This redemption would be taxable if the returns exceed INR 1 lakh, the same rule which is applicable on the returns earned from ELSS schemes.
- ULIPs vs ELSS – tax implication on switching
Under ULIPs you can change the investment fund if the market is volatile. You would not have to pay any type of tax on the amount that you switch between funds.
Under ELSS schemes, switching is also treated as redemption. If you are withdrawing from one scheme and investing into another, the amount withdrawn will be taxed if the returns are in excess of INR 1 lakh.
So, while ULIPs and ELSS schemes give the same tax benefits on investments, it is in other scenarios when ULIPs prove to be a better investment option that ELSS schemes.
ULIPs vs ELSS – other differences
Besides the all-too-important tax angle, ULIPs and ELSS schemes have other differences too. These include the following –
| Basis of difference | ULIPs | ELSS |
| Type of funds | ULIPs offer all types of investment funds – equity, debt, balanced, money market, etc. You can choose any one fund or a combination of funds as per your risk appetite. ULIPs are, therefore, suitable for all types of investors | ELSS is an equity-linked fund which is suitable for the risk-loving investors. You cannot invest in debt instruments when you choose ELSS schemes and so the scheme is not ideal for risk-averse investors |
| Lock-in duration | 5 years | 3 years |
| Financial needs met | ULIPs can be issued as child ULIPS wherein they secure the financial future of the child even in the absence of the parent. There are also pension ULIPs which create a series of regular income after retirement. Thus, different types of ULIPs are available for fulfilling different types of financial needs | ELSS investments are not linked to specific needs. You can invest in ELSS funds and use the returns for meeting any type of financial need that you have |
| Charges | ULIPs include a range of charges like premium allocation charge, policy administration charge, fund management charge, mortality charge, etc. | Only entry load and exit loads are applicable in case of ELSS funds |
| Insurance coverage | ULIPs provide insurance coverage | Insurance coverage is not provided under ELSS schemes |
| Regulated by | ULIPs are offered by insurance companies which are regulated by the IRDA | ELSS are offered by mutual fund houses which are regulated by SEBI |
| Risk | Risk depends on the type of investment fund selected and how the fund is managed through switching | Risk is high since ELSS invests primarily in equity oriented securities |
ULIPs vs ELSS – which one to choose?
Now you know the meaning and features of ULIPs and ELSS and also the points on which they differ. To choose you should assess your investment requirements. You can choose ELSS schemes when –
- You have a short-term investment horizon
- You don’t mind taking risks
- You want lower charges to be deducted from your investment
- You don’t need insurance coverage
ULIPs, on the other hand, prove suitable when –
- You need an insurance cover
- You have a long-term investment horizon
- You want to manage your investments as per the market movements
- You want to save the maximum possible tax
So, assess these factors and then make your choice between ULIPs and ELSS. Both of these investment avenues give market-linked returns but they are quite different from one another. Understand their differences and see which avenue suits your investment strategy and then choose the best alternative.
Frequently Asked Questions
- Is there any charge on partial withdrawal?
Partial withdrawals, up to a specified limit, are usually free under most unit linked plans. However, under some plans there might be a charge applicable. You should check the charges before making a withdrawal
- Can I surrender a ULIP before the completion of five years?
No, ULIPs can be surrendered only after the completion of the first 5 years. If you surrender beforehand, the fund value would be transferred to a discontinued policy fund where it would remain till five years are over. Once the plan completes five years, you would get the fund value available in the discontinued policy fund.
- Are only ELSS returns taxed at 10% if they exceed INR 1 lakh?
No, the aggregate return which you earn in a financial year from equity oriented investments like equity mutual funds, ELSS, equity shares, etc. are subject to a tax of 10% if they exceed INR 1 lakh.
- What are the entry and exit loads?
Entry load is the charge which is deducted from your investment when you invest in a mutual fund scheme. Exit load is the charge which is deducted from your fund value when you redeem your mutual fund scheme.
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