ULIP vs Mutual Fund is a golden contest of financial instruments. This is a classic example for wise investors to understand and take home a lesson about investing. Stick around as we reveal the layers of this lesson.
This long-drawn contest should not baffle investors, who are wise enough to peek through the numbers. This article is just about that, read through and discover through the numbers – Which investment is a better choice for you.
What are ULIP & Mutual Funds?
If you are familiar with the products, scroll down to check the investment performance…
For the uninitiated, ULIP refers to Unit Linke Insurance Plan and ELSS refers to the Equity Linked Savings Scheme.
ULIPs are life insurance policies with a large chunk of investment attached to it. In a way:
“ULIP = Mutual Fund + Term Insurance“
But there’s a huge difference. Now you can truly call ULIPs, a life insurance plan where you can choose to invest as per your risk-return comfort.
More Investment Choices
ULIPs offer a break from the risk-free-low-return nature of traditional life insurance investments. Unlike endowment or money back plans, ULIPs offer market-linked returns. You can invest in pure equity-based or balanced (mix of equity and debt) fund options through ULIPs.
Endowment and money back life insurance plans, collectively called traditional life insurance, do not give the choice to investors. But these traditional schemes do offer a fixed return (defined benefit) and carry negligible investment risk.
Unit Allocation Like Mutual Funds
If you are familiar with mutual funds you would know that mutual funds allocate units at NAV (Net Asset Value) to the investors. For example, if you invest Rs. 10,000 in a mutual fund at the NAV of Rs. 10, you can get approx. 1000 units of the fund.
Similarly, ULIPs also assign units to their investors against the invested money. Also, there is an inbuilt life insurance cover for the policyholder. Thus, the name, ‘Unit Linked Insurance Plan.’
One key feature of ULIPs that you should remember is that the life cover only lasts until your accumulated corpus grows bigger than life cover benefit. For example, if you are investing in a ULIP which has Rs. 10 lakhs as the death benefit, the life cover will go away once your investment corpus grows more than Rs. 10 lakhs.
Read more at “How Do Unit Linked Insurance Plans (ULIPs) Work?“
While ULIP is one type of life insurance investment, mutual funds are a collage of multiple different kinds of investment options. For example, you can invest in a debt portfolio, equity portfolio, or a mixed portfolio in a single ULIP plan. However, if you want to invest in a debt portfolio through a mutual fund, you have a long list of various debt funds to choose from. Similarly, there are numerous equity-oriented mutual funds, each with their distinct risk-return characteristic.
Now, we know that one key feature of a ULIP is the tax-saving, which is enough to tilt the investor consensus in its favour. Thus, we are obliged to choose a mutual fund scheme that can match the tax-saving benefit of ULIPs.
Tax Saving Mutual Fund
Closest a mutual fund scheme that comes to the tax-saving capacity of a ULIP is an ELSS or equity-linked savings scheme. Thus, the comparison must be between these two schemes. However, not before we have set the ground rules.
ELSS is simply an equity-oriented mutual fund with 80C eligibility. That means you can claim a deduction under section 80C when you invest in an ELSS scheme. Another feature where ELSS and ULIPs stand at par is that equity investment is managed passively in both cases.
You can invest as much as you want in both ELSS and ULIP. However, section 80C limits of the financial year will cap the maximum tax exemption. Thus, both schemes fair at par for the extent of tax-saving they can offer.
Read more about ELSS here: “ELSS – Learn What is Different, How They Work?”
ULIP vs Mutual Fund – Key Differences
|Provided by Life Insurance Companies||Provided by Mutual Fund Houses specifically established to sell mutual funds only|
|Regulated by Insurance Regulatory & Development Authority (IRDA) of India||Regulated by SEBI and self-regulatory body Association of Mutual Funds in India (AMFI)|
|Includes a life insurance cover||Does not include any insurance|
|All ULIPs carry tax benefits under section 80C provided investments meet the tax-saving conditions||Only Equity Linked Saving Schemes (ELSS) plans offer tax-saving benefit under 80C. (Specified mutual funds under RGESS also offer tax benefit under 80CCG for the first-time equity investors)|
|Five-year lock-in period before withdrawal is allowed from the plan||Maximum lock-in period is three years|
|Multiple fund options under one roof can serve all investors with different risk appetite||Each mutual fund carries different risk-return profile. Tax-saving funds are typically equity oriented|
Comparing ULIP & Mutual Fund
Since mutual funds are different from ULIP when it comes to the basic benefits, we cannot compare them straightaway. We need to build a similarity between both ULIP and Mutual Fund (ELSS) to make them comparable to each other. The comparable products have similar benefits to investors.
Making ULIP & Mutual Funds Comparable
As you can clearly choose between a life insurance need and investment need. A more comparable option would be, as many financial planners also suggest from time to time:
ULIP vs ELSS + Term Life Insurance
For our understanding, we would compare a ULIP with a life cover of Rs. 10 lakhs with an ELSS + a term life cover of Rs. 10 lakhs.
Premium & Regular Investment
The ideal premium for an Rs. 10 lakh ULIP plan comes about Rs. 1 lakh a year. This is the maximum annual investment we will assume for ELSS + Term cover combo as well.
Thus, for the ELSS Term combination the term insurance premium will be deducted out of Rs. 100,000 and rest will accumulate under ELSS.
ULIP vs Mutual Fund + Term Cover
Both schemes have recurring charges applicable to the invested amount. Following are the type of expenses both investment plans will involve:
|ULIP||ELSS + Term Insurance|
|Mortality Charge for the life insurance cover||Premium for the term life cover|
|Premium Allocation Charges (% of premium paid)||Transaction charges
(Fixed amount about Rs. 150 and Rs. 100)
|Policy Administration Charges (% of corpus but limited by a fixed limit)||-|
|Fund Management Charge (% of corpus)||Recurring Charges (% of AUM/corpus, depends on the size of the mutual fund)|
! Details of expenses provided at the end of the article
Provided the kind of expenses both schemes have, ELSS clearly has a simpler expense ratio. But over a longer-term, ULIPs recurring charges are lower than ‘ELSS + Term Plan’.
The exception, however, is the first five years (see figure “Expense Ratios” above). The figure shows the amount of money that will go towards expenses in both the schemes every year. The chart considers an annual investment of Rs. 100,000 for 25 years. The policy holder’s age is 30 years when the investment starts.
For the first five years, ULIPs charges (recurring + fixed) remain above ELSS schemes. From sixth year onwards the ULIP’s expense ratio dramatically drops below ELSS and continues, resulting in a huge expense ratio.
The Return on Investments
Investment Yield or rate of return on your investment is the rate of return that you can compare with other investments. Both investments produce different yield results for the same investment period as well as for the entire tenure. For example, in the first five years of investment ULIP’s ROI is slightly more than 8% p.a. while ELSS has given more than 10% p.a. (see the “Yield Comparison Chart” below)
The comparative yield curves for both schemes, when market returns are at 15% p.a., will look like this:
The yield curve for ULIP surges ahead of the ELSS + Term Plan in the 13th year of investment. For the first 12 years, the ELSS + Term combination offers you higher returns.
Growth in Invested Funds
The yield curve gives a picture of comparable annual returns on both ULIP and ELSS (mutual fund) investments. But in simple terms, we should know which one will deliver more funds at our doorstep. So, here is accumulated funds by both investments.
How Much Growth Both Options Offer?
Remember we assumed market returns at 15% p.a. However, both ULIP and ELSS will generate a slightly lower return due to the scheme expenses. So here’ what the chart gives out:
- In the first Five-years ELSS accumulates higher value
[Rs. 6.8 Lakhs in ULIP vs. Rs. 7 Lakhs in ELSS]
- At the end of 10th year as well, ELSS scores better than ULIP but only slightly
[Rs. 19.88 Lakhs in ULIP vs. Rs. 19.97 Lakhs in ELSS]
- At the end of 20th year, ULIP leaves ELSS behind
[Rs. 91.3 Lakhs in ULIP vs. Rs. 86.5 Lakhs in ELSS]
- By the end of the tenure of 25 years, ULIP investment is far ahead of ELSS
[Rs. 1.79 Crores in ULIP vs. Rs. 1.65 Crores in ELSS]
The results are pretty much the same with a lower rate of return on the market, except that the accumulated sums will be lower in both schemes. But one thing is clear:
“ELSS + Term Plan is a good idea if you are looking at 10 years or less of investment. But if you plan to stick for more than 10 years ULIP might be more rewarding.”
Does ULIP Win Hands Down?
Not really. There are quite a few caveats to higher ULIP returns than just the holding term of 12 years. Following are those conditions:
- Annual Investment: Both estimates (given above) assume that money is invested annually in both ULIP and ELSS + Term
- Life Insurance Need: Both estimates assume that investor needs a life cover of Rs. 10 lakhs
- Long-Term Commitment: Both estimates assume that both ULIP and ‘ELSS + Term’ investors are committed for a long period, i.e. 10 to 15 years at least
- You are Comfortable Investing in Equity: The estimates assume that investor has chosen equity fund in the ULIP, and does not switch to debt in the investment term
Changing any of the four conditions will alter the estimates in favour of ELSS. Also, out of the three the ‘long-term commitment’ is the trickiest. It is here the ULIPs suffer the most. Since, if you want tax deduction as well as good investment return, you must commit for at least 15 years. That too, with annual investment, and not with one time or partial premium payment term.
Also, if we remove term insurance from ELSS investment, ELSS will have lower annual expenses. Though ULIP will still offer better returns, ELSS will enjoy a longer period before ULIP beats it.
When Should You Invest in ULIP?
Investing in ULIP is not less rewarding than any mutual fund. In fact, it can be more rewarding provided you can continue investing for long enough.
ULIPs could prove more rewarding for you if you are okay with the following:
- Minimal withdrawal commitment for 15 to 20 years
- No problems in investing a fixed sum each year or month
- Value the life insurance cover that comes with the investment
- Want market-linked returns, tax benefits and option to switch to safer investments later
See “When & Why ULIP Investment is the Best Choice? & 5 Ways ULIPs Can be Great Goal Achievement Plans” for more details on making the most of ULIP investments.
When to Invest in ELSS?
If you are an experienced investor and know where you are putting your money, you probably already know the answer. But, if not, here are the conditions when ELSS will score over ULIPs. If you:
- Do not want to commit for a very long period, but still can hold off for more than 5 years
- Are unsure if you can invest the same amount next year
- You already have a term insurance cover and do not need additional life insurance
- You are comfortable with the ups and downs of the equity market
This is an objective analysis, based on the current expense ratios of ULIPs and ELSS schemes. The assumed expense ratios are provided below. Any change in these ratios in the future may warrant a revisit to the calculation board. Till then the analysis provided above holds true.
See “Secrets of ELSS Investment for a Delightful Ending” for simple choices to help you make the most out of your ELSS investments.
Why ULIP Wins in Long Run?
The answer to this slow catapult lies in the way charges are applied in both ELSS and ULIPs. Both schemes have their own advantages and disadvantages. For example:
- Advantage ULIP: The recurring charges are applied to the premium paid instead of fund value. Unlike ELSS, where the amount of charges applied automatically goes up if the investment performs better.
- Advantage ELSS + Term: The mortality charges are constant over the investment period. Unlike ULIP, where the mortality charges increase as the policyholder ages.
Expense Ratios for ULIPs & ELSS
Expense Ratios for ULIPs
Please understand that these charges are fluid and may change over time. In fact, few insurers offer ULIP plans with much lower charges. However, we took moderate charges to stay conservative in our approach to estimating the return on investment.
|Age of insured (or policy holder) in years|
|Rs. per 1000 of Sum Assured|
Premium Allocation Charge
|Year of investment|
|% of Premium|
Policy Administration Charge
|for the First Year||0.21% p.m. [Or] 2.52% p.a. (up to Rs. 6000 p.a.)|
|for Other Years||0.10% p.m. [Or] 1.20% p.a. (up to Rs. 6000 p.a.)|
Fund Management Charge
|% of Total Corpus||1.35% p.a. throughout the investment period|
How Do Different Expenses Work in ULIPs?
- Premium Allocation Charge is applicable on the premium paid amount
- Policy Administration Charge applies to the accumulated corpus. Most ULIPs put a ceiling to the charge
- Mortality Charge is an amount deducted from the paid premium or the accumulated corpus (when premiums are not paid). It is based on:
- Age of the insured, &
- Life insurance sum assured in the policy
- Fund management charge also applies to the total accumulated corpus
Expense Ratio for ELSS Schemes
ELSS scheme charges are as of May 2017. These charges may also change over time. We will revise our estimates as and when it is necessary or affecting the outcomes.
|Transaction Charges||1st Investment||
|Premium for Term Insurance of 10 Lakhs||Rs. 4650 p.a.|
How Does Recurring Charge Work in Mutual Funds?
Recurring charges in Mutual Funds are deducted on the total asset under management (AUM) in the fund, and not on the individual corpus of a customer. Example below:
- If you invest in a mutual fund which has a corpus of less than Rs. 100 crores, your annual recurring charge will be just 2.5% of the invested money.
- However, if you invest in a fund with a total corpus of close to Rs. 400 crores, your annual expense ratio (ER) will be approximately 2.31%.
- Similarly, a mutual fund scheme with a total AUM of more than Rs. 1000 crores will incur only 2.05% of AUM as an annual recurring charge.
Other Assumptions During the Comparison
- The investor is 30 years of age for both ULIP and ELSS
- Return on the stock market is consistent with 15% CAGR
- Total Asset Under Management (AUM) of ELSS is Rs. 1000 crore or more
Purpose of Investigation & Research
While most blogs and analysts will side with either, we endeavoured to investigate the truth. Our sole purpose was to present an unbiased and objective answer. Our answer is based on our analysis of multiple factors associated with both ELSS and ULIPs.
If anyone ever tells you that ELSS is better, you can confidently say that they are assuming. With this 25-year performance record for both ELSS and ULIP, you cannot get a clearer answer.
As for the learning as an investor you should take home is simply this,
“No investment instrument is bad; you just need to know how to use them.”
In a country where maximum investments occur due to tax rebates, it is not surprising that tax-exempt schemes get the limelight. People have asked this question ever since the ULIPs and Mutual Funds competed in the investment space.
At one time even the regulators fought for the control over who sets the rules of the game. But, this simple step by step analysis proves that designers for both the investment products are smart. Now, it’s up to you, the investor, to be smart about your choices.