ULIPs have been in the news for all the wrong reasons. They were often sold (or rather mis-sold) as assured return products when they were not. There were occasions when they were sold as mutual funds when they also had an insurance component to them. All these factors forced the IRDA to clamp down heavily on ULIP sales. Things did change partially when the Union Budget 2018 imposed 10% tax on long term capital gains (LTCG). This was payable at a flat rate of 10% of the gains (without indexation) if the gains were more than Rs.1 lakh during the fiscal year. Since ULIPs were exempted from this tax and equity MFs (including ELSS) were made subject to this tax, the issue is whether it made ULIPs more attractive?
Mutual funds remain the preferred choice for a variety of reasons
There is a saying in financial planning that never let taxes drive your investment choices. That applies to your choice of ULIPs too. Here are some key reasons why MFs remain a preferred option over ULIPs.
- First and foremost, the key to any good investment product is transparency. When we talk of transparency, we are talking about transparency with reference to loads, initial costs and the portfolio. ULIPs will surely score low on all these counts. ULIPs do not make a transparent disclosure of their portfolio and hence ULIP holders do not exactly know where their money is invested in. Secondly, since ULIPs have an insurance component plus high loading in the initial years which are not very clear to most people.
- Combining insurance and investment is never a great idea to begin with. From a financial planning perspective it is always better to demarcate your insurance and investments. You are better off buying a term policy for your insurance cover and invest the balance in mutual funds. Don’t go for off the shelf solutions that ULIPs offer.
- What about the LTCG tax on mutual funds? It is a case of too much being made out of a tax imposition. If profits are taxable, losses can be written off and also carried forward for 8 years. Don’t forget that you can actually plan your withdrawals in such a way as to keep annual capital gains within the Rs.1 lakh limit. Mutual fund SWP can be an answer to your questions.
- Continuing on the subject of LTCG tax on mutual funds, the impact appears to be large over longer periods of time but the actual impact on yield is quite small. For instance, after a 10 year holding period, the difference in CAGR yield after considering LTCG tax is just 100 basis points. If you hold for 20 years, then the impact is less than 50 basis points. So, it could be a case of much ado about nothing.
- The lock in benefit of mutual funds. ULIPs come with a mandatory lock-in period of 5 years during which time you can only withdraw with a very huge forfeiture. Mutual funds are liquid from day 1 and even if you opt for an ELSS, the lock-in period is much lower at just 3 years. ULIPs are rarely profitable after 5 years; normally it is 8 years.
- Even if you consider the impact of LTCG tax, ULIPs need 10 years in normal market conditions to be as profitable as mutual fund. Till then, upfront loads on ULIPs are just too high to be profitable.
- If you are buying MFs or ULIPs as part of your financial plan (as you should be doing) logically, you will find that mutual funds are more amenable and flexible. When you create your financial plan, there are clear demarcations of insurance needs and investment needs. All that you need to do is to buy pure risk covers for insurance needs and invest in mutual funds of equity and debt for wealth creation over the long term. As a solution, mutual funds fit more eminently in that position.
The crux of the story is that, despite the LTCG tax on equity funds from Budget 2018, mutual funds are a more suited to your financial plan as compared to ULIPs. Now, the choice must be a lot clearer when it comes to ULIPs versus mutual funds!
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