It is that time of the year when all eyes will be searching for investment options for tax savings. Nobody would want to pay more tax. It would be safe to presume that the story can’t be too different for you. That’s why the ‘Tax Man’ has provided you with numerous tax savings options under the Income Tax Act. The best part, these are legal, effective, and smart options to not only save on taxes, but to also make your money grow.
PPFs, life insurance policy, bank FDs, and health insurance are tax savings options that millions of Indians have been exploring over the years. However, in the past decade, mutual fund tax savings SIPs, ELSS, and ULIPs have become highly popular options since they are smart and effective investments. Owing to its link with the equity markets, ELSS provides much higher returns compared with conservative tax savings options such as PPFs and bank FDs. These higher returns would often help you set-off the increasing inflation, providing you with a stronger chance of saving more for your safe and secure future.
When it comes to tax savings, the common perception is that ULIPs are similar to ELSS. The primary reason behind this perception is that both are tax savings instruments and invest into the equity markets. Let’s closely examine ULIPs and ELSS and understand, which of the two is a better and effective tax savings investment option.
Type and nature of the products
ULIPs are insurance cum investment products, which would provide you with the option of investing into the equity markets, debt markets, or hybrid funds. In case of a ULIP investment, to avail tax benefits, the minimum sum assured must be 10 times of the annual premium that you are prepared to pay. On the other end, ELSS are pure equity mutual funds, which come with no insurance. Thus, there’s no minimum premium commitment, which makes ELSS a popular option for tax savings.
ULIPs generally have a lock-in period of 5 years whereas ELSS has a lock-in period of 3 years. Among all the tax savings instrument, ELSS has the lowest lock-in period, making it a popular tax savings investment option. Equity provides better returns in the long term. Therefore, in case of ULIPs, if you have opted for equity, you need to stay invested for long term to enjoy better returns. ELSS is by nature an equity investment. Although it has a lower lock-in period compared with ULIPs, you are advised to stay invested for a longer term, since equity can be volatile in the short term.
Let’s now look at the surrender charges for both these instruments. In case of ULIPs, in the lock-in period of 5 years, the surrender charges in the first year could be as high as 6% or Rs. 6000, whichever is lower. Surrender charges would keep on reducing to around 2% or Rs. 2000, whichever is lower in the fourth year. From the fifth year, there are no surrender charges. However, whenever you would surrender your plan within the lock-in period of 5 years, whatever is your fund value after deducting the surrender charges is moved to a discontinued policy (DP) fund. You can liquidate your fund value only after the completion of your 5-year lock-in period. Your money in the DP fund earns an interest of around 4%.
On the other end, you cannot redeem ELSS investments within the lock-in period of 3 years. In case of ELSS, irrespective of your mode of investment (SIP or lumpsum), each unit bought is subject to the lock-in period. Let’s assume you have invested in ELSS through SIP and within the 3-year lock-in period, you want to discontinue your ELSS investment. This is exactly where ELSS enjoys a major advantage over ULIPs. You could decide to stay invested in the ELSS fund up to the extent of the amount invested through monthly SIPs to earn interest. This facility is completely missing in case you were to invest in ULIPs. In fact, in case of ULIPs, you could stay invested in the fund only if you have paid your premium for 5 years. This is another major tick against ELSS as a tax savings option.
ULIPs would provide you with a balancing option. In case of ULIPs, you could change the allocation of your funds based on your various life stages and changing risk propensity. During your youngers days, you could have a higher allocation of equity compared with debt, since your risk propensity is the highest at this point of your life. However, you can change this as you grow older to a higher debt allocation compared with equity, since your risk propensity might have reduced appreciably by this stage of your life.
On the other hand, ELSS is a pure equity investment with no debt exposure. You could opt for the dividend option for periodic booking of your profits. However, ELSS is still a preferred option because you could always balance your portfolio to diversify risk through other safe debt options. This would not only provide you with higher returns from ELSS through the equity markets, it would also help you balance your risk more effectively.
Charges and clarity factors
There are many charges involved in case of ULIPs. These include, premium allocation charges (paid upfront), policy administration charges (flat fee or %), fund management charges (part of NAV), mortality charges for insurance (deducted by selling units), surrender charges in the lock-in period, and service charges (applied before allocation of units). Charges vary depending on the fund policies. However, you would bear a maximum chunk of the charges in the first 5 years of your plan. Another point to note is that the transparency is low since you do not know the exact amount that’s been invested after paying all these charges.
Moreover, you have to stay invested in ULIPs for at least 8-10 years to get good returns largely due to the fact that you would incur maximum charges during the 5-year lock-in period. That said, many people like ULIPs since it acts as a one-stop-shop for serving their insurance and investment needs. However, please note that the insurance here does not come at a cheap price. For instance, for a cover of Rs. 1 cr, you would need a ULIP of Rs. 5 lakhs. You would need just need a term plan of Rs. 10000 for getting the same cover. Therefore, you need to invest wisely.
On the other hand, in case of ELSS, all you need to pay is just one fee, which is a fund management fee or something called as the expense ratio. This is capped at a maximum limit of 2.5% and is a percentage of your investment demand. Some ELSS funds even operate at 1.25% of expense ratio. Please note that the expense ratio is part of the NAV and thus, it is factored into it. Moreover, compared with ULIPs, the strategies and objectives of an ELSS fund are clearly defined. Mutual funds publish the stocks they buy as part of your investment periodically. The best part is that ELSS funds come under the purview of market regulator SEBI. ULIPs on the other hand are governed by the insurance regulator IRDA, but invest into the securities market. Thus, you are advised to keep insurance and investment separate. You can always go in for a separate term insurance plan when you buy ELSS. Please note that the insurance products under ULIPs tend to keep you under insured in most of the cases.
The Tax Factor
You are allowed a tax exemption of up to Rs. 1.5 lakhs under the overall limit u/s 80C in case of ULIPs as well as ELSS. That said, in case of ULIPs, if you surrender your policy during the lock-in period, please note that your tax benefits would be reversed and you would have to pay taxes. If the sum assured would be less than 10 times the annual premium, the maturity amount would be added to your gross income and would be taxed according to the tax slab that you fall under. However, if the sum assured is more than 10 times of the annual premium, then the investment amount returns and the maturity amount are totally tax free. If the annual premium you pay is more than Rs. 1 lakh, it attracts TDS of 2%.
On the other hand, in case of ELSS your investment, returns and maturity amount are completely exempt from tax. Moreover, if you have opted for a dividend option, the dividends received are completely tax free your you and your mutual fund.
Return on investment (ROI)
It is difficult to figure out average ROI in ULIPs because plans and policy options vary with different insurance companies. However, average ROI from ULIPs in the past 5 years have been in the range of 5-12% per annum. In case of ELSS, it is much easier for you to determine as well as track the average ROI since most funds would have either one or maximum two ELSS options. Average annual returns from ELSS funds over the last five years is around 14%. Some of the best funds have given around 19% annual returns.
If these points are not enough to highlight ELSS as a better 80C option than ULIPs, please note that in case of ULIPs, the time taken for surrender and redemption process is 15-20 days, which is only 3 days for ELSS. To know more about the best tax saving investment options, give a missed call at 08010968308 or write to us at [email protected]
Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.