Understand Your Fund Better
Written on Saturday, September 10, 2016
By Investor's India
Ulips and ELSS are not the same products as have totally different structures and fulfil different needs. They both differ in terms of their objectives as on one hand ELSS is purely an investment product then, Ulip is a meant not to provide investment returns but to offer insurance cover. The confusion between the two is probably because of the fact that both make investments in equity markets and are tax-saving instruments. We can look on the following differences to find out which one can be bought at what point of time.
Five differences between Ulips and ELSS
The two products are often confused because both are tax-saving instruments. Here’s what you should know before putting your money in either.
Investment or Insurance
ELSS, or equity-linked saving schemes, are diversified equity funds that invest in stocks. These are pure investment instruments and do not offer any insurance. While Ulip is an insurance-cum-investment product sold by insurance companies. Ulip investors have the option to invest in equity, debt, hybrid, and money market funds. The minimum sum assured is 10 times the annual premium (seven times if age of entry is above 45 years). Since as told earlier the two are confused because of the fact that these make investments in equity markets and are tax-saving instruments. But, when buying any product, one should be clear about one’s objective and not mix insurance with investment.
In ELSS funds, your investment remains locked for three years, since you cannot withdraw before three years, no exit load is applicable. The Ulips come with a lock-in period of five years. While you cannot quit the Ulip, you can discontinue the premium, wherein a discontinuance charge is levied and the balance amount is moved to a discontinuation fund. An intelligent investor is the one who do not quit a Ulip or an ELSS fund even after the lock-in period because, equity investment gives the best returns in the long term of 7-10 years. In case of Ulips, this period is ideally 10-15 years.
Charges & transparency
ELSS funds have only one charge, which is the fund management fee or expense ratio. This is around 3% and the cost is adjusted in the NAV of the scheme, not charged separately. Due to high transparency in transaction the investor knows how much amount was invested and can calculate the return therefrom. But the case of ulip is completely different from Elss. In Ulips, almost 60% of the charges are incurred in the first few years, including the premium allocation charge (percentage of premium for charges before allocating units, initial and renewal expenses and agent commissions); mortality charge (insurance cost); fund management fee; policy administration charge; fund switching charge and service tax deduction. The remaining money is invested in the market. As the charges start reducing only after 3-4 years, the investment and, hence, returns will be very low. Since, Ulips are meant for long-term and you want good returns then, you need to stay invested for at least 10-15 years. The transparency in the case of Ulips is low because the investor do not know the exact amount being invested. Also, some charges are levied by reducing the units, not deducting from NAV, further reducing transparency.
Both instruments have equal amount of eligibility for deduction of up to Rs 1.5 lakh under Section 80C. Since in case of ELSS, the lock-in is for three years, resulting in long-term capital gains, which invite zero taxation for equity investment. ELSS funds follow the EEE mode, wherein investment, capital gains and maturity amount are tax-free.
The Ulips have different scenario, if you surrender before the lock-in period, any deduction claimed earlier is reversed and you have to pay tax. And the maturity amount is tax-free only in the case of death of the policyholder. If the premium is more than 10% of sum assured, the maturity proceeds are added to the insured’s income and taxed at applicable rate. If the premium is more than 10% of sum assured and the proceeds for a year exceed Rs 1 lakh, tax of 2% is deducted at source.
In the case of ELSS, there is no option of switching and one can’t touch the investment before the lock-in period. However, you can opt for the dividend option to ensure periodic booking of profits. Ulips offer a switch option, which means that you can alter the ratio of invested amount in different funds (equity, debt, hybrid etc). This allows you to shift your funds as per the risk exposure at different life stages. So, while you are young, you can go for equity, but with age you can shift to debt. You can also switch out of equity if you expect the markets to fall. But do remember, there may be limited number of free switches.