ULIP vs Mutual Fund: What’s Better Considering the New 12.5% LTCG Tax?
Published on December 22, 2024
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ULIP vs Mutual Fund: What’s Better Considering the New 12.5% LTCG Tax?
With the introduction of the 12.5% LTCG tax on equity mutual fund gains exceeding ₹1.25 lakh, many investors are now evaluating whether ULIPs (Unit Linked Insurance Plans) or equity mutual funds offer better returns. While both options have their advantages, the new tax regime on mutual funds can make ULIPs a more attractive investment choice under certain conditions.
Key Tax Changes: What You Need to Know
From 2024 onwards, Long-Term Capital Gains (LTCG) on equity mutual funds will be taxed at 12.5% on gains above ₹1.25 lakh in a financial year. Previously, the tax was 10% on gains above ₹1 lakh, but the increase to 12.5% significantly affects the post-tax returns for equity mutual fund investors, especially those with larger gains.
LTCG Tax on Mutual Funds (2024 onwards):
12.5% tax on capital gains exceeding ₹1.25 lakh in a financial year.
The first ₹1.25 lakh in gains is tax-free.
In comparison, ULIPs still provide tax-free maturity benefits, meaning any gains accumulated within the policy are not subject to any capital gains tax upon maturity, making ULIPs a potentially more tax-efficient investment, especially for long-term investors.
How ULIPs Can Offer Better Returns Than Mutual Funds (With the Right Conditions)
1. No Premium Allocation Charges and Policy Administration Charges
ULIPs can outperform mutual funds in terms of returns only if there are no premium allocation charges or policy administration charges. These charges can otherwise reduce the amount of money being invested in the fund and thus the returns over time.
Premium Allocation Charges: In some ULIPs, a portion of the premium is deducted upfront to cover distribution costs, which means the amount invested in the fund is lower than the actual premium paid.
Policy Administration Charges: These are charges levied by the insurer for the cost of administering the policy. When such charges are high, they can reduce the net investment and erode the returns.
Therefore, for ULIPs to offer better returns than mutual funds, premium allocation charges and policy administration charges should be nil or as low as possible.
2. Fund Management Charges (FMC)
The Fund Management Charge (FMC) in ULIPs is capped by the IRDAI at 1.35%, with some ULIPs offering even lower FMCs. This makes them relatively cost-competitive compared to equity mutual funds, which typically have an expense ratio ranging from 0.5% to 2% (depending on whether they are actively or passively managed).
Low FMC in ULIPs: If the ULIP offers an FMC close to the 1.35% cap or even lower, it can be a very attractive choice, especially considering that mutual funds typically have higher costs, especially for actively managed funds.
3. GST and Mortality Charges
In addition to FMC, ULIPs also have GST and mortality charges. The GST on premiums in ULIPs is generally 18%, which applies to the total premium paid. However, when compared with the 12.5% LTCG tax on equity mutual fund gains, ULIPs can still come out ahead, especially if they offer lower mortality charges (which are linked to the life cover within the policy).
Mortality Charges: These charges depend on the sum assured and can be lowered by choosing a higher life cover. For example, selecting 10x the annual premium as life cover can significantly reduce mortality charges and improve the overall return from the ULIP.
Once the fund value reaches the sum assured, mortality charges typically stop, further improving the net return from the ULIP.
ULIP vs Mutual Fund: Key Differences
1. Taxation:
ULIPs offer tax-free maturity, so the entire corpus is available without any capital gains tax. Additionally, ULIPs offer tax deductions on premiums under Section 80C, providing immediate tax relief.
Mutual Funds are subject to the 12.5% LTCG tax on gains above ₹1.25 lakh, reducing the effective return for investors who accumulate large gains over time.
2. Fund Management Charges (FMC):
The FMC in ULIPs is capped at 1.35%, making them competitive, especially when compared to higher expense ratios in actively managed mutual funds.
Mutual funds can have expense ratios ranging from 0.5% to 2%, depending on the fund type.
3. Liquidity and Flexibility:
Mutual Funds offer higher liquidity, with the ability to redeem or switch funds at any time. There are also no lock-in periods (except for ELSS funds, which have a 3-year lock-in).
ULIPs have a 5-year lock-in period, but after that, you can make partial withdrawals or switch between funds. However, the lock-in may be a disadvantage if you need immediate access to your investment.
4. Mortality Charges and Life Coverage:
ULIPs combine life insurance with investment. Mortality charges are levied based on the sum assured, but these charges decrease once the fund value equals the sum assured.
Mutual Funds do not offer any life insurance coverage. You would need to buy a separate life insurance policy.
Conclusion:
ULIPs offer significant tax advantages with tax-free maturity, especially with the 12.5% LTCG tax on mutual fund gains. For investors seeking both life coverage and wealth creation in one product, ULIPs can offer better returns if they have no premium allocation charges, no policy administration charges, and lower FMCs.
Mutual Funds, while offering greater liquidity and flexibility, are now subject to 12.5% LTCG tax, which can reduce returns for investors who generate large capital gains over time.
In conclusion, ULIPs can be a more attractive investment option when the goal is long-term wealth accumulation combined with life insurance benefits, especially when charges are kept to a minimum. However, for investors who prioritize liquidity and flexibility, mutual funds remain a viable choice, though they are less tax-efficient due to the new LTCG tax regime.
With the introduction of the 12.5% LTCG tax on equity mutual fund gains exceeding ₹1.25 lakh, many investors are now evaluating whether ULIPs (Unit Linked Insurance Plans) or equity mutual funds offer better returns. While both options have their advantages, the new tax regime on mutual funds can make ULIPs a more attractive investment choice under certain conditions.
Key Tax Changes: What You Need to Know
From 2024 onwards, Long-Term Capital Gains (LTCG) on equity mutual funds will be taxed at 12.5% on gains above ₹1.25 lakh in a financial year. Previously, the tax was 10% on gains above ₹1 lakh, but the increase to 12.5% significantly affects the post-tax returns for equity mutual fund investors, especially those with larger gains.
LTCG Tax on Mutual Funds (2024 onwards):
12.5% tax on capital gains exceeding ₹1.25 lakh in a financial year.
The first ₹1.25 lakh in gains is tax-free.
In comparison, ULIPs still provide tax-free maturity benefits, meaning any gains accumulated within the policy are not subject to any capital gains tax upon maturity, making ULIPs a potentially more tax-efficient investment, especially for long-term investors.
How ULIPs Can Offer Better Returns Than Mutual Funds (With the Right Conditions)
1. No Premium Allocation Charges and Policy Administration Charges
ULIPs can outperform mutual funds in terms of returns only if there are no premium allocation charges or policy administration charges. These charges can otherwise reduce the amount of money being invested in the fund and thus the returns over time.
Premium Allocation Charges: In some ULIPs, a portion of the premium is deducted upfront to cover distribution costs, which means the amount invested in the fund is lower than the actual premium paid.
Policy Administration Charges: These are charges levied by the insurer for the cost of administering the policy. When such charges are high, they can reduce the net investment and erode the returns.
Therefore, for ULIPs to offer better returns than mutual funds, premium allocation charges and policy administration charges should be nil or as low as possible.
2. Fund Management Charges (FMC)
The Fund Management Charge (FMC) in ULIPs is capped by the IRDAI at 1.35%, with some ULIPs offering even lower FMCs. This makes them relatively cost-competitive compared to equity mutual funds, which typically have an expense ratio ranging from 0.5% to 2% (depending on whether they are actively or passively managed).
Low FMC in ULIPs: If the ULIP offers an FMC close to the 1.35% cap or even lower, it can be a very attractive choice, especially considering that mutual funds typically have higher costs, especially for actively managed funds.
3. GST and Mortality Charges
In addition to FMC, ULIPs also have GST and mortality charges. The GST on premiums in ULIPs is generally 18%, which applies to the total premium paid. However, when compared with the 12.5% LTCG tax on equity mutual fund gains, ULIPs can still come out ahead, especially if they offer lower mortality charges (which are linked to the life cover within the policy).
Mortality Charges: These charges depend on the sum assured and can be lowered by choosing a higher life cover. For example, selecting 10x the annual premium as life cover can significantly reduce mortality charges and improve the overall return from the ULIP.
Once the fund value reaches the sum assured, mortality charges typically stop, further improving the net return from the ULIP.
ULIP vs Mutual Fund: Key Differences
1. Taxation:
ULIPs offer tax-free maturity, so the entire corpus is available without any capital gains tax. Additionally, ULIPs offer tax deductions on premiums under Section 80C, providing immediate tax relief.
Mutual Funds are subject to the 12.5% LTCG tax on gains above ₹1.25 lakh, reducing the effective return for investors who accumulate large gains over time.
2. Fund Management Charges (FMC):
The FMC in ULIPs is capped at 1.35%, making them competitive, especially when compared to higher expense ratios in actively managed mutual funds.
Mutual funds can have expense ratios ranging from 0.5% to 2%, depending on the fund type.
3. Liquidity and Flexibility:
Mutual Funds offer higher liquidity, with the ability to redeem or switch funds at any time. There are also no lock-in periods (except for ELSS funds, which have a 3-year lock-in).
ULIPs have a 5-year lock-in period, but after that, you can make partial withdrawals or switch between funds. However, the lock-in may be a disadvantage if you need immediate access to your investment.
4. Mortality Charges and Life Coverage:
ULIPs combine life insurance with investment. Mortality charges are levied based on the sum assured, but these charges decrease once the fund value equals the sum assured.
Mutual Funds do not offer any life insurance coverage. You would need to buy a separate life insurance policy.
Conclusion:
ULIPs offer significant tax advantages with tax-free maturity, especially with the 12.5% LTCG tax on mutual fund gains. For investors seeking both life coverage and wealth creation in one product, ULIPs can offer better returns if they have no premium allocation charges, no policy administration charges, and lower FMCs.
Mutual Funds, while offering greater liquidity and flexibility, are now subject to 12.5% LTCG tax, which can reduce returns for investors who generate large capital gains over time.
In conclusion, ULIPs can be a more attractive investment option when the goal is long-term wealth accumulation combined with life insurance benefits, especially when charges are kept to a minimum. However, for investors who prioritize liquidity and flexibility, mutual funds remain a viable choice, though they are less tax-efficient due to the new LTCG tax regime.