ELSS and ULIPs are often pitted against each other, and during the tax-saving season, the debate keeps resurfacing. Both products offer tax benefits under Section 80C of the Income Tax Act 1961 and are considered investment products. Investors may find it confusing as to which one is better, and it is natural to compare the two.
So, let's dive into a deeper analysis of ULIP vs ELSS
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ULIP is an insurance product with an investment aspect. The premium paid for ULIP policies is invested in multiple fund options, such as debt, equity, or both. ULIPs also have life insurance coverage, and death benefits paid are higher than the sum assured. Additionally, ULIPs have a lock-in period of 5 years, during which the money invested cannot be withdrawn.
ELSS is a type of mutual fund that invests primarily in equity shares of companies listed on the stock exchange. The returns on these funds are market-linked and tend to be higher than those of FDs and other investments.
However, these returns are subject to market fluctuations, and ELSS does involve a risk of losing money. Additionally, ELSS has to be locked in for a period of three years. This means the invested capital cannot be withdrawn before three years are completed.
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One of the fundamental differences between ULIPs and ELSS is that ELSS is sold as a mutual fund, whereas ULIPs combine insurance and investments. Another aspect to realize is that insurance companies offer ULIPs. When the investor dies, their nominee will receive the higher sum insured in the case of a ULIP, whereas, in an ELSS, they will receive the total value of the funds at the time of redemption.
ELSS aims at corpus building like most equity funds but has a lock-in period of 3 years. Most experts will suggest that holding it for 5-7 years provides better benefits. ULIPs aim to provide life coverage to the insurer so that they can get some capital appreciation.
ELSS is a high-risk product because it is a mutual fund that segregates 65-80% of funds to equities. ULIPs are less risky than ELSS because the policy coverage is guaranteed even when the returns are not. Also, a ULIP has equity, debt, or a hybrid fund unit that decides the risk factor involved. ULIPs are generally low-risk. So, investors can easily switch from equity to debt funds during the mid-lifecycle of the investment.
ELSS uses all investors' money to buy funds, whereas ULIPs do not. So, it is natural that ELSS has a higher chance of delivering better returns. Also, if a ULIP invests in debt securities, the returns are lower than those of equity funds but more stable. ELSS is also known to generate higher returns than ULIPs.
Both ULIPs and ELSS are exempt from tax up to Rs. 1.5 lakhs in a given financial year under Section 80C. But once the units of ELSS and ULIP are redeemed after lock-in periods of 3 and 5 years, they are subject to tax. ELSS is taxed like equity funds, whereas ULIPs are taxed per the new government policy under 8AD from 1 February 2021. Earlier, ULIPs were tax-free under Section 10(10D), but now they have tax exemptions up to Rs. 2.5 lakhs.
ELSS has more liquidity than ULIPs because it has a smaller lock-in period. Investors prefer ELSS because it has the shortest lock-in time among all tax-saving tools under Section 80C. The lock-in period of a ULIP is five years. However, there is no option to withdraw either ULIP or ELSS prematurely.
One key parameter that separates the two products is that switching between options in assets is available on ULIP. ELSS is an equity fund, so investors cannot opt for an alternate asset allocation. On the other hand, ULIP is an insurance product that invests in funds, and investors can choose the funds.
Another critical aspect of these investments is the expense ratio, which is percentage-based. Fund houses levy specific charges for managing the funds. A higher expense ratio means paying a higher percentage of the returns as a fee for professional fund management.
In the end, this impacts the returns that investors receive. ELSS, on the other hand, has a lower expense ratio and ranges from 1.35 to 2.5, whereas ULIP starts from 2.25.
Factors | Unit-Linked Insurance Plan (ULIP) | Equity-Linked Savings Scheme (ELSS) |
Product Features | ULIPs are a combination of insurance and investments. | ELSS is a mutual fund. |
Objectives of Investment | ULIPs aim to provide life coverage to the insurer so that they can get some capital appreciation. | ELSS aims at corpus building like most equity funds. |
Risks Involved | ULIPs are less risky than ELSS | ELSS is a high-risk product. |
Returns | As ULIP invests in debt securities, the returns are lower. | ELSS uses all investors' money to buy funds, so returns are higher. |
Tax Benefits | Tax deducted under Section 80C. | ELSS is taxed at 10% on and above Rs. 1 lakh. |
Liquidity | ULIPs have a lock-in period of 5-7 years. | ELSS has the shortest lock-in time - 3 years |
Switching up Options | Switching between options in assets is available on ULIP | ELSS is an equity fund, so investors cannot opt for an alternate asset allocation. |
Expense Ratio | ULIP has a higher expense ratio that starts from 2.25 | ELSS has a lower expense ratio and ranges from 1.35 to 2.5. |
Regarding ULIP vs. ELSS, both are tax-saving options under Section 80C but are entirely different in nature. They are regulated by different regulatory bodies: the Insurance Regulatory and Development Authority (IRDA) and the Securities and Exchange Board of India (SEBI). IRDA regulates ULIP, which is an insurance product with mutual fund benefits. On the other hand, SEBI regulates ELSS as a mutual fund in totality.
So, when planning your investment portfolio, remember to discuss the different lock-in terms, risk-return portfolios and taxation rules.