A ULIP is a life insurance policy which invests in equity and debt thereby generating market linked returns along with providing insurance cover.
We look at how ULIPs fare in comparison to mutual funds.
Short-Term Capital Gains (STCG)
The short-term capital gains tax on equity mutual funds is 15% for holding periods of less than one year. For debt mutual funds it is as per your slab which could be as much as 30% for holding periods of less than three years. On the other hand, there is no STCG on ULIPs.
One major difference is that you cannot pull money out of ULIPs for the first five years and hence there is no question of attracting STCG whether or not, it is imposed. However, you can switch between ULIP equity and debt funds without redeeming. This will not incur any tax liability.
Long-Term Capital Gains Tax (LTCG)
The LTCG on equity funds which was earlier zero is now 10% (except for an annual tax-free allowance of Rs 1 lakh). Gains before 31st January 2018 are also exempt. For debt funds, this tax is 20% with the benefit of indexation. In case of ULIPs, there is no LTCG. The maturity proceeds of a ULIP are fully exempt under Section 10(10)(D) of the Income Tax Act.
The dividends on equity funds will now be taxed at 10%. In case of debt funds, the tax and applicable cess take the rate to about 28%. There is no corresponding tax on ULIPs. However, this may be a somewhat academic argument because ULIPs do not pay dividends.
Since ULIPs also invest in equity and debt, they are often sold as investment products, in direct competition with mutual funds. This is unlike term insurance which only pays out on death and has no maturity value. Term insurance is a pure insurance product.
ULIPs also contain higher charges such as premium allocation charge, mortality charge and policy administration charge in addition to the fund management charges. This is unlike mutual funds whose charges are heavily regulated by SEBI and are contained in a single charge known as the ‘expense ratio.’
Should you go for ULIPs?
Despite the relative tax advantage, the high charges and opaque nature of ULIPs do not make them a superior investment product. If you wish to buy insurance, term insurance will typically get you a roughly 10 times higher cover for the same amount of premium. For pure investing, mutual funds remain lower cost, more transparent products which also offer higher liquidity.
If you are looking specifically at retirement, you can consider the NPS. There are no taxes (STCG or LTCG) on switching between NPS funds from debt to equity and vice versa. On the flip side, you cannot withdraw until the age of 60 (with a few exceptions). However, retirement is meant to be a very long-term goal and an age lock-in of 60 is a reasonable feature to build into a retirement product.