There is often some confusion associated with Unit-Linked Insurance Plans [ULIPs] and Equity-Linked Savings Scheme [ELSS]. Both these financial instruments are eligible for tax benefits under the Income Tax Act.
However, there are some differences between these products and it is important to understand these before you make an investment decision. Here are five such differences.
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Life coverage
ULIPs are insurance plans that combine life cover along with investments. A portion of the premium may be invested in various products such as debt, equity, money market, or hybrid instruments. The minimum sum assured is ten times the annual premium, which is seven times if you are over 45 years old at the time of investing.
In comparison, ELSS plans are diversified equity schemes that primarily invest in the stock markets. Unlike ULIPs, ELSS plans are only investment products and do not provide any life cover.
It is important to clearly understand your personal needs before you decide to invest in either of these two products.
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Taxability
Investments made in a ULIP plan or ELSS plan are eligible for tax deductions under section 80C of the Income Tax Act. The deduction is limited to a maximum amount of INR 1.5 lakh per annum.
ELSS plans fall under the EEE [Exempt, Exempt, Exempt] category. This means the investment amount, the earnings thereon, and the maturity proceeds are also exempt from taxes. The minimum lock-in period for ELSS plans is three years.
Investments made in ULIPs are eligible for a tax deduction when you remain invested for at least five years, which is the minimum lock-in period. Moreover, the maturity proceeds are also eligible for tax benefits. However, if the annual premium exceeds 10% of the sum assured, the maturity proceeds are added to your income and taxed at your regular income tax rate.
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Transparency and charges
ELSS funds levy only a single charge known as the ‘expense ratio’ or the fund management fee. This fee is adjusted against the Net Asset Value [NAV] of the fund and not separately charged. This allows you to determine the potential returns on your investment thereby providing complete transparency.
On the other hand, when you invest in ULIPs, a higher percentage of the total charges are levied during the initial investment period. The premium allocation charge, fund management fee, mortality charges, and policy administration charges are some of the fees associated with ULIP investments. After deducting all these charges, the balance amount is invested in different financial instruments. The charges are higher initially and reduce when you remain invested for the long-term, which may deliver lower returns on your investments. Moreover, you do not exactly know where your money is invested, which offers limited transparency. Additionally, some insurers may levy some of the charges by reducing the number of units and not the NAV, which also reduces the transparency.
This is an important difference between ULIP vs. ELSS and should be considered when you make the investment decision.
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Switching option
A portion of your ULIP premium is invested in different financial instruments. ULIPs allow you to switch your investment from one fund to another in case of any such need. Therefore, you are able to mitigate the risk posed due to market volatility. Additionally, as you grow older, you may reduce your equity exposure by switching your investment to debt instruments. Insurance companies offer a limited number of free switches and you need to consider this while making any switches.
In comparison, such versatility is not available when you invest in ELSS plans. You cannot switch or exit your investment until the end of the minimum lock-in period. However, you may consider the dividend option to avail of regular returns on your investments.
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Lock-in period
When you invest in a ULIP, you need to hold your investment for at least five years. During this period, you are unable to exit the investment or discontinue paying the premium. In case, you want to discontinue before the lock-in period, you will have to pay discontinuation charges with the balance money shifted to a discontinuation fund.
On the other hand, the minimum lock-in period for ELSS investments is three years. You cannot exit before the end of this period, which means there is no exit load for such investments.
Although you may exit both ULIP and ELSS at the end of their respective lock-in periods, it is recommended you hold your investments for a longer duration to maximize your returns. It is advisable you hold your ULIP investment for ten to 15 years while remaining invested in ELSS plans for seven to ten years is recommended.
ELSS and ULIPs are risky investments because the returns are dependent on the market performance. However, ULIPs are versatile because, in case of a market downturn, you have the flexibility of switching to debt products to prevent loss of your investment. This option is not available when you invest in ELSS plans. Moreover, ULIPs include life coverage, which is not included in ELSS. There are certain ULIP benefits and specific advantages of investing in ELSS plans. However, you need to take into consideration some factors while making your investment decision. Some of these include your risk taking capability, expected returns on investment, financial objective, and investment horizon.
It is recommended you research all the different options and evaluate your specific needs to make an accurate investment decision.