ULIP (Unit Linked Insurance Plan) and ELSS (Equity Linked Savings Scheme) are popular investment options offering tax benefits under Section 80C of the Income Tax Act. ULIPs combine insurance with investment, allowing individuals to secure life cover while earning market-linked returns over time. They cater to long-term financial goals, offering flexibility to switch between funds. ELSS, on the other hand, is a pure equity mutual fund that provides higher returns with a shorter lock-in period of 3 years. While ELSS is ideal for wealth creation, ULIPs are suited for investors seeking both insurance protection and investment growth.
Choosing between ULIP and ELSS depends on whether the priority is insurance with investment (ULIP) or pure wealth creation through equity investments (ELSS). Both options are excellent tools for tax savings while promoting disciplined financial planning.
1.What is ULIP?
A ULIP (Unit Linked Insurance Plan) is a financial product that combines life insurance and investment into a single plan. It ensures financial protection for your loved ones while allowing you to invest in market-linked funds such as equity, debt, or a mix of both to achieve long-term goals.
ULIPs are ideal for investors who want the dual benefits of insurance and wealth creation. When you invest in a ULIP, a portion of your premium goes toward life insurance coverage, and the remaining amount is invested in funds of your choice, based on your risk profile. ULIPs are flexible, allowing you to switch funds and choose between equity, debt, or balanced funds to optimize returns.
However, ULIPs come with various charges that are deducted from the premium before investment. These charges are important to understand for calculating actual returns and costs.
Charges in ULIPs
Here is a breakdown of the various charges associated with ULIPs, along with their simple definitions:
- Premium Allocation Charges
- Definition: A portion of the premium deducted upfront to cover expenses such as distribution fees, underwriting, and commissions.
- Example: If you pay ₹100 as a premium, 5% may be deducted as a premium allocation charge, leaving ₹95 for investment.
- Mortality Charges
- Definition: These charges cover the cost of life insurance and provide financial protection to your family in case of the policyholder’s death.
- Example: If the sum assured is ₹10 lakh, the insurer charges based on age, policy term, and health risk.
- Fund Management Charges
- Definition: A fee charged for managing the investment funds (equity, debt, or balanced) by professional fund managers..
- Example: Typically, fund management charges are capped at 1.35% per annum of the fund value.
- Policy Administration Charges
- Definition: A charge for managing and maintaining the ULIP policy, including paperwork, services, and administration expenses.
- Example: This charge is deducted monthly and is often fixed, like ₹100 per month.
- Fund Switching Charges
- Definition: A small fee charged when you switch your investments from one fund (e.g., equity) to another (e.g., debt).
- Example: Insurers may allow a few free switches annually, after which they charge ₹100–₹500 per switch.
- Partial Withdrawal Charges
- Definition: A fee charged when you withdraw part of your investment after the lock-in period of 5 years.
- Example: Some policies charge ₹100–₹300 per partial withdrawal.
- Surrender Charges
- Definition: A penalty imposed if you exit or surrender the ULIP policy before the lock-in period of 5 years.
- Example: Charges decrease over time; higher penalties apply if surrendered early.
- Discontinuance Charges
- Definition: Fees imposed for stopping premium payments before the policy term ends.
- Example: Depending on premium size, it may be capped at ₹6,000 in the first year.
Here the ULIP policy has annual premium charges for 10 years and its deductions in percentage:
Policy Year | Annual Premium | Mortality Charges (₹) | Other Charges (₹) | GST (₹) | Total Deductions (₹) | Percentage Deducted |
1 | 2,50,000 | 6,015 | 9,984 | 2,880 | 18,879 | 7.55% |
2 | 2,50,000 | 6,182 | 13,164 | 3,482 | 22,828 | 9.13% |
3 | 2,50,000 | 6,376 | 16,462 | 4,111 | 26,949 | 10.78% |
4 | 2,50,000 | 6,606 | 20,353 | 4,851 | 31,810 | 12.72% |
5 | 2,50,000 | 6,853 | 24,328 | 5,613 | 36,794 | 14.72% |
6 | 2,50,000 | 7,139 | 28,579 | 6,413 | 42,131 | 16.85% |
7 | 2,50,000 | 7,505 | 31,519 | 7,024 | 46,048 | 18.42% |
8 | 2,50,000 | 7,903 | 35,125 | 7,722 | 50,750 | 20.30% |
9 | 2,50,000 | 8,343 | 39,221 | 8,586 | 56,150 | 22.46% |
10 | 2,50,000 | 9,173 | 43,191 | 9,527 | 61,891 | 24.76% |
1. Years 11 to 15:
- Charges escalate further due to the policyholder’s age and the compounding effect of fund growth on management fees:
- Year 15: ₹94,027 (37.61%).
2. Years 16 to 20:
- By the 20th year, total charges deducted annually reach ₹1,32,308.
- This includes ₹28,939 (mortality), ₹82,656 (other charges), and ₹20,713 (GST).
- Percentage deducted: 52.92%.
Key Insights
- Early Years:
- Total deductions in Year 1 are only 7.55% of the annual premium, leaving most of the premium for investment.
- Later Years:
- By Year 20, deductions increase to 52.92% due to higher mortality charges and other charges (such as fund management fees, policy administration, and GST).
- Compounding Effect:
- As fund value grows over time, charges on the accumulated value (like fund management fees) increase proportionally.
How Do ULIP Charges Impact Returns?
ULIPs provide the flexibility to invest in market-linked funds and the potential for long-term wealth creation, but they come with various charges that can significantly impact returns, especially in the initial years. These charges reduce the actual amount that goes into investments, dragging down potential returns.
Example:
Let’s assume you invest ₹1 lakh in a ULIP policy. Here’s how the charges are typically divided in the initial years:
- Premium Allocation Charges (Approx. 10-15%):
Around ₹10,000 to ₹15,000 is deducted upfront as premium allocation charges to cover distribution fees and commissions. - Mortality Charges (Approx. 1-2%):
About ₹1,000 to ₹2,000 goes towards life insurance cover. - Fund Management Charges (Approx. 1.35% annually):
This charge applies to the investment portion and is deducted regularly, further reducing the investment growth. - Policy Administration Charges:
Fixed monthly charges (e.g., ₹100–₹500) are deducted to maintain the policy.
After deducting these charges, the actual investment in funds is typically around 70-75% of the premium in the first year. In our example, if you invest ₹1 lakh:
- ₹30,000 or more is taken for charges and insurance.
- Only ₹70,000 or less is invested in equity, debt, or balanced funds.
Why Getting Market Returns in ULIPs is Complicated
- High Initial Charges: In the early years, more than 30% of the premium goes toward charges and insurance, reducing the base investment amount.
- Regular Deductions: Charges like fund management fees and policy administration fees are applied annually, slowing down the growth of your investment.
- Impact of Returns: While market-linked returns are advertised, the actual returns investors receive are often lower due to deductions over time.
Disadvantages of ULIPs:
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- High Insurance Charges
ULIPs come with significant insurance-related costs, such as mortality and morbidity charges, which increase with age. These charges reduce the actual amount invested in market-linked funds, significantly affecting overall returns. - Commissions
ULIPs involve hefty commissions paid to agents, which are deducted from the premium. This adds another layer of cost, leaving less of your premium for actual investment. This is particularly detrimental in the initial years, where a large portion of the premium is eaten up by these commissions. - Lack of Transparency
ULIPs lack clarity in terms of fund allocation, charges, and performance. Policyholders often do not have a clear understanding of how their money is being utilized, making it difficult to evaluate whether the product is delivering value. - Returns Are Capped Around 8% After Deductions
Despite being market-linked, the multiple deductions—such as mortality charges, fund management fees, administrative costs, and GST—bring down the effective returns. Even in favorable market conditions, ULIPs rarely offer returns exceeding 8%, making them less competitive than other investment options like mutual funds. - Not a Wealth Creation Product but a Wealth Destroyer
Due to the combination of high charges, low transparency, and capped returns, ULIPs fail to serve as an effective wealth creation tool. Instead, they often lead to wealth erosion over time, especially when compared to standalone investment options like ELSS or direct equity investments.
- High Insurance Charges
2.What is ELSS?
ELSS, or Equity Linked Savings Scheme, is a type of mutual fund that primarily invests in equity and equity-related instruments. It is popular among investors for its ability to offer both tax savings and the potential for higher returns through equity investments. ELSS is a perfect option for individuals who want to save taxes under Section 80C of the Income Tax Act while also growing their wealth over time.
An ELSS is a diversified equity mutual fund that invests predominantly in stocks across various sectors and companies of different sizes, such as large-cap, mid-cap, and small-cap. The key feature of ELSS is its tax-saving benefit, which allows investors to claim deductions of up to ₹1.5 lakh per year under Section 80C.
The other standout feature of ELSS is its lock-in period of 3 years, which is the shortest among all tax-saving options under Section 80C. While other instruments like Public Provident Fund (PPF) or National Savings Certificate (NSC) have longer lock-in periods (15 years and 5 years, respectively), ELSS offers greater flexibility and liquidity after just 3 years.
How Does ELSS Work?
Investment in Equity:
The money you invest in an ELSS is pooled together with funds from other investors and managed by professional fund managers. This money is then invested in the stock market, in companies across different sectors and industries. The goal is to generate high returns by capitalizing on market growth over time.
Tax Deduction Under Section 80C:
Investments in ELSS qualify for tax deductions of up to ₹1.5 lakh per financial year under Section 80C. This means that if you invest ₹1.5 lakh in ELSS, you can reduce your taxable income by ₹1.5 lakh, leading to significant tax savings.
Lock-in Period:
ELSS comes with a mandatory 3-year lock-in period. During this time, you cannot redeem or withdraw your investment. This lock-in ensures disciplined investing and gives your money enough time to grow in the equity market.
Returns:
ELSS returns are market-linked since they are based on equity investments. Over the long term, equity investments have the potential to generate significantly higher returns compared to traditional tax-saving options like Fixed Deposits or NSC. However, ELSS returns can fluctuate in the short term due to market volatility.
Maturity and Liquidity:
After the 3-year lock-in period, you can redeem your ELSS investment. If you want, you can also stay invested beyond 3 years to allow your money to grow further, as there is no upper limit on the investment duration.
Equity: ELSS Mutual Fund SIP Calculator:
Benefits of ELSS:
Tax Savings:
ELSS provides tax deductions of up to ₹1.5 lakh per year under Section 80C, which can help save up to ₹46,800 annually (for individuals in the 30% tax bracket). This makes ELSS an efficient tax-saving option.
Short Lock-in Period:
ELSS has a lock-in period of just 3 years, the shortest among all Section 80C investment options. After this period, you are free to redeem your investment or continue to stay invested.
Potential for Higher Returns:
ELSS invests in the stock market, offering the potential for higher returns over the long term. Historical data shows that equity markets tend to outperform other asset classes like debt or fixed-income products over time.
Disciplined Investment:
Since ELSS has a lock-in period, it encourages investors to stay invested for at least 3 years. This long-term approach helps ride out market fluctuations and benefit from the power of compounding.
SIP Option:
ELSS allows you to invest through Systematic Investment Plans (SIPs), which lets you invest a fixed amount regularly (monthly or quarterly). SIPs make it easier to start small, reduce market risks, and build wealth gradually over time.
Diversification:
ELSS funds invest across a variety of sectors, companies, and market capitalizations, which spreads risk and ensures diversification. Even if some stocks underperform, others may balance the portfolio and help achieve growth.
ELSS vs Other Tax-Saving Options
Feature | 4. ELSS | 5. PPF | 6. NSC | 7. Fixed Deposit |
Lock-in Period | 8. 3 years | 9. 15 years | 10. 5 years | 11. 5 years |
Returns | 12. Market-linked | 13. 7-8% (fixed) | 14. 6-7% (fixed) | 15. 6-7% (fixed) |
Risk | 16. High | 17. Very Low | 18. Low | 19. Low |
Investment Type | 20. Equity | 21. Debt | 22. Debt | 23. Debt |
Tax Benefit on Returns | 24. Partially Tax-Free | 25. Fully Tax-Free | 26. Taxable | 27. Taxable |
From the table above, ELSS stands out due to its shorter lock-in period and the potential to deliver higher returns through equity investments. While it carries higher risk due to market fluctuations, it rewards long-term investors significantly.
Disadvantages of ELSS (Equity Linked Savings Scheme):
- Market-Linked Risk
ELSS invests primarily in equity (stocks), which makes it a high-risk investment. If the stock market performs poorly, the returns from ELSS may be negatively impacted. This risk makes ELSS unsuitable for conservative investors or those seeking stable returns. - No Guaranteed Returns
Unlike fixed-income instruments such as Public Provident Fund (PPF) or Fixed Deposits (FDs), ELSS does not provide guaranteed returns. The performance of ELSS funds depends entirely on the market, which means you could lose money in adverse conditions. - Mandatory Lock-In Period
ELSS has a lock-in period of 3 years, meaning you cannot withdraw your investment before this duration. While this is shorter compared to other tax-saving instruments, it limits liquidity for investors who may need funds urgently. - Tax on Long-Term Capital Gains (LTCG)
Though ELSS offers tax-saving benefits on the invested amount, returns are not entirely tax-free. Gains above ₹1 lakh in a financial year are taxed at 10% under LTCG, which reduces the net returns for investors. -
Comparative Analysis of ULIP and ELSS:
Aspect ULIP (Unit Linked Insurance Plan) ELSS (Equity Linked Savings Scheme) Structure Combines insurance and investment. Premium is split between life insurance and fund investment. Pure investment product focused on equity funds with no insurance component. Returns Typically 4%-8% due to high charges (mortality, fund management, etc.). Historically 10%-12%, as it invests entirely in equities. Risk Moderate to high, depends on chosen fund (equity or debt). High, as it invests primarily in equities. Lock-In Period 5 years 3 years Tax Benefits Premiums and maturity amount are tax-free under Section 80C and 10(10D). Investment amount is tax-free under Section 80C, but returns above ₹1 lakh are taxed at 10%. Charges High charges (mortality, fund management, etc.), reducing overall returns. Low charges (expense ratio), ensuring better returns compared to ULIPs. Example Investing ₹1,00,000 annually: ₹20,000 may go toward insurance; only ₹80,000 is invested in funds. Returns are reduced by charges. Investing ₹1,00,000 annually: The entire amount is invested, yielding higher returns. Who Should Invest in ULIP and ELSS?
ULIP:
Investors Seeking Insurance + Investment: Ideal for individuals who want a single product that provides both life insurance coverage and investment opportunities.
Long-Term Financial Goals: Suitable for long-term goals like retirement, children’s education, or wealth creation, as it requires a longer commitment.
Moderate Risk Tolerance: Best for those comfortable with moderate risks, as ULIPs allow switching between equity and debt funds.
Tax Benefits: Good for investors looking to save taxes under Section 80C while combining insurance benefits.ELSS:
Equity Investors with Tax-Saving Goals: Suitable for individuals looking to invest in equities while saving taxes under Section 80C.
High Risk Appetite: Ideal for investors willing to accept market volatility for potentially higher returns.
Shorter Lock-In Period: Best for those looking for tax-saving instruments with a shorter lock-in period of 3 years.
Wealth Creation: Perfect for those aiming to create wealth over the long term through market-linked growth.Conclusion
- ULIPs and ELSS funds each have distinct benefits. ULIPs provide both insurance protection and an opportunity to grow your money, while ELSS focuses on equity investments and tax benefits. Deciding between them depends on your financial needs, how much risk you’re willing to take, and your long-term goals. Consider what matters most to you—insurance, investment growth, or tax savings—when making your choice.