The LTCG tax has restarted the fight between these two arch rivals
Ever since the LTCG tax was announced in the Budget, insurance companies have been busy highlighting the tax-free nature of Ulips. But the taxability of income is not the only parameter on which an instrument should be judged. We examined Ulips and mutual funds (MFs) on seven key parameters. Ulips nearly knocked out mutual funds in the taxability round. Read on to know how they did in the subsequent rounds and which of the two eventually emerged the winner.
ROUND I: TAXABILITY
Ulips always had the edge, but the new LTCG tax gives them more punch.
Even before the Budget proposed to tax long-term gains from stocks and mutual funds, Ulips had an edge over equity mutual funds. If balanced schemes or equity mutual funds were held for less than one year, the shortterm capital gains were taxed at 15%. But since Ulips are insurance products, the short-term gains were tax free under Section 10(10d).
That advantage will become even bigger after the new LTCG tax kicks in from 1 April. As many insurers have been quick to point out, while gains from balanced and equity funds will be taxed at 10%, income from Ulips will be completely tax free.
The tax-free advantage of Ulips extends beyond equity funds to the fixed income space. Ulips not only offer equity funds but also debt and liquid fund options to investors. In this space, income from fixed deposits is taxed at the marginal rate while LTCG from debt funds are taxed at 20% after indexation. However, gains from Ulips are tax free.
Score: ULIPs 90, MFs 10
ROUND II: COSTS
Mutual funds are very cheap but some new online Ulips also have low charges.
Ulips haters have often used the high charges of these plans to beat them with. But high Ulip charges ended way back in 2010. The cost structures of some new Ulips are so frugal that they almost compete with the low-cost direct plans of MFs. Most online Ulips don’t have policy administration or fund allocation charges. If you don’t add the mortality charges, the annual charges of the Click2Invest Ulip from HDFC Life are less than 1.5%. At the same time, the mortality charges levied by Ulips reduce the net investment of the policyholder. Insurance companies are trying to reduce the impact of the mortality charge. The Wealth Plus policy from Edelweiss Tokio Life makes additional contributions to the fund corpus. Bajaj Allianz Life Insurance has launched Goal Assure, a Ulip that pays back the mortality charges at the end of the term.
Score: ULIPs 40, MFs 60
ROUND III: RETURNS
MFs consistently deliver better returns. This has a big impact in the long term.
Insurance companies argue that mortality charges should not be drawn into the equation because that goes into providing life coverage to the policyholder. Even if we examine only the NAV-based returns, MFs score over Ulips. Data from Morningstar shows that Ulip returns are 100-300 basis points lower than those of MFs. The average largecap Ulip fund grew 15.51% in the past year whereas the average large-cap MFs rose 18.83%.
This gap in performance can have a big impact in the long run of 15-20 years. In the past five years, ₹1 lakh invested in the average large-cap Ulip would have grown to ₹1.96 lakh (annualised return of 14.42%). The same amount put in the average large-cap MFs would have grown to ₹2.03 lakh (15.25% annualised return). If extrapolated over 20 years, even this thin difference can fatten the MF corpus by ₹30,000. Of course, the new LTCG tax for equity funds will pare the returns in the coming years.
Score: ULIPs 35, MFs 65
ROUND IV: FLEXIBILITY
Investors can switch funds or stop investing, but Ulip buyers can’t
A Ulip is a multi-year commitment. The buyer has to keep paying the premium for the full term of the plan. Also, investing in a Ulip is like buying a closed-ended fund that will mature in 15-20 years. Worse, Ulip investors are stuck with the same insurer and policy for the full term. In contrast, there are no such constraints on a MF investor. He can easily shift from a poor performing scheme to a better fund. He can exit anytime he wants or remain invested for the long term. He can make partial withdrawals or make additional investments without any hitch. Ulips also allow additional top-up investments, but these are treated as single premium payments and mortality charges are deducted from them.
The switching facility in Ulips provides some flexibility. The investor can switch from equity to debt and vice-versa without incurring a tax liability. Insurers claim this makes Ulips a good rebalancing tool.
Score: ULIPs 30, MFs 70
ROUND V: TRANSPARENCY
Fund portfolios simple and accessible, Ulips opaque with complex charges.
MFs are widely tracked by several agencies. Investors can peek into their portfolios, find out their allocation to sectors, market segments and even individual stocks. Ulips also offer the same information, but they are not so widely tracked and very few investors would know which is the best performing Ulip.
Also, Ulip charges are a bit complicated. Some of them are not built into the NAV but levied by cancellation of units. While the NAV of the Ulip might have risen by 12%, the corpus value would have grown by only 10% because some units got cancelled. In contrast, MFs are fairly transparent on charges. The fund management charges are built into the NAV and there is an exit load for redeeming before the minimum holding period.
Score: ULIPs 10, MFs 90
ROUND VI: LIQUIDITY
Investors can exit MFs anytime, but Ulips have a five-year lock-in period.
While both MFs and Ulips are long-term investments, MFs are very liquid. An investor can exit any time he wants, and even make partial withdrawals if required. Ulips have a five-year lock-in period, after which partial withdrawals can be made. The good thing is that unlike the pre-2010 Ulips, there are no surrender charges after five years.
Some people argue that by forcing the policyholder to remain invested for at least five years, Ulips help develop the saving habit. On the other hand, most MF investors face no such hurdles. Most tend to withdraw investments within 2-3 years. This fickleness is inimical to wealth creation. The longer you remain invested, the higher are your returns.
Score: ULIPs 20, MFs 80
ROUND VII: EASE AND CHOICE
MFs offer wider choices, easy to start. Ulips offer fewer choices, take time.
If you already invest in MFs and your KYC formalities are done, you can invest online in any MF without any additional paperwork. Ulip investors don’t have that luxury. Even after they fill up the form online and make the payment, the paperwork needs to be completed offline. This can include medical tests and even scrutiny of the income tax return of the individual if he has sought a very large life insurance cover.
MFs also offer a wider choice to investors. Those looking for stable growth can go for large-cap funds and the more adventurous investors can invest in mid-cap and small-cap schemes. Flexicap funds give you the best of all worlds. Some insurers offer a wide bouquet of Ulip funds, but mostly the choice is between equity, debt and liquid funds.
Score: ULIPs 30, MFs 70
Ulips charges have come down significantly and these plans will become more attractive after the LTCG tax kicks in from 1 April. However, mutual funds score well on all other parameters. If insurers want Ulips to click with investors, they must make them more transparent and offer greater choices to policyholders.