As an advisor, you often come across this question. If the goal is to get a life cover and to achieve capital appreciation, there are two primary options. First is a combination of mutual funds (offered by AMCs) and a term insurance plan, and the other is to get ULIPs – Unit Linked Insurance Plans (offered by a life insurance company) that offers both.
At first glance, ULIPs look good because a single product meets both objectives. However, there is a lot more to it than the convenience. Read further to learn, and to educate your clients about the various aspects that need to be considered:
- Cost vs Cover
Perhaps one of the key considerations for any investment is the cost associated with owning and maintaining the asset. The higher the cost, the lesser the amount available for investing. While newer ULIPs are more affordable than its previous avatar, they still levy various charges such as mortality charges, fund management charges, premium allocation charges, etc. Most of these are frontloaded and are levied in the initial years. Hence, the money invested is lesser in the initial stages of the policy term.
Moreover, the sum assured offered by ULIPs is rarely adequate to take care of the needs of a family in case the principal breadwinner is no longer there. On the other hand, term insurance offers a large cover at a much lower premium.
- Taxation
Both ULIPs and term insurance plans offer tax exemption under section 80C of the Income Tax Act, 1961. Even ELSS mutual funds offer the same. Hence, there is not much to differentiate. However, the reintroduction of the Long-Term Capital Gains (LTCG) tax of 10% on gains of more than Rs. 1 lakh in a fiscal achieved through equity mutual funds or directly from stocks, without indexation benefits, may lead some individuals to pick ULIPs, which are outside the purview of the LTCG tax.
However, it is essential to note that even after LTCGs tax, mutual funds, especially equity funds have the potential to offer significant capital appreciation over the long term. One must also note that gains made till 31st January 2018 are grandfathered, and they are taxable only if they are above Rs. 1 lakh in a fiscal. Moreover, the tax structure should not be the guiding force behind any investment, especially one that you plan to hold for 15-20 years.
- Lock-in Period
ULIPs come with a lock-in of 5 years. Hence, it is recommended that the investor stays invested through the tenure of the policy. In case the policy is surrendered before the lock-in period, discontinuance charges are levied. The life cover is paused, and the corpus is transferred in the discontinuance policy (DP) fund where it earns an interest rate of just 4% p.a. The money remains in the DP fund
until the lock-in.
Even surrendering the policy after the lock-in is not recommended as most of the associated charges are levied within the initial years of the policy. When it comes to mutual funds, there are no such penalties, and there is no lock-in period either (except for ELSS funds that have a 3-year lock-in), so the investor is free to redeem whenever required. Most mutual funds schemes charge a nominal exit load if the units are redeemed within a year of allotment. However, there is no exit load if they are redeemed after a year.
Mutual funds + term insurance can be a good combination, and since insurance and investments are different goals, they should not be clubbed. While mutual funds can help in capital appreciation over the long term, a term plan can provide a substantial life cover to safeguard the needs of a family in case of an untoward incident.
IDFC Mutual Fund offers unbiased advice about personal finance and brings to you several types of mutual fund schemes to meet your investment needs.
Subscribe to our page for more insights on investments and personal finance. Visit www.idfcmf.com for more details.