ULIP VS ELSS : Not Just A Matter Of Choice!

Undoubtedly, ULIP figures heavily in the minds of investors seeking an option for tax saving because the scheme also offers life insurance cover. However, does this attraction compensate for the other benefits offered by ELSS? Read on to know how the two fare against each other 

In the recently announced Union Budget, presented on February 1, 2020, Finance Minister Nirmala Sitharaman has proposed a new tax regime that has the potential to silence the age-old question of which is the best option for tax saving. Under the proposed Income Tax slabs, which will be optional, individuals will not be entitled to exemption or deductions, including under Section 80C and 80D, LTC, housing rent allowance, among others. Our analysis shows that for someone earning up to Rs. 15 lakhs per year, it makes sense to be in the old regime and avail the benefits given under different sections of the Income Tax Act 1961.

Now, the harder question is which among the two is a better option – Unit-Linked Insurance Plan (ULIP) or Equity-Linked Saving Scheme (ELSS)? For obvious reasons, insurance agents believe ULIP is better while mutual fund distributors believe that ELSS is more preferable. However, in this debate, an investor is confused as to which among the two is the better tax saving option. In this article, we will try to figure out which offers better potential for tax saving and returns. We will compare both the products in terms of their different features. 

Further, our comparison will also be on various fronts such as cost, benefits, returns, etc.

Asset Under Management

ULIP is one of the most popular tax saving products in the market. At the end of March 2019 it had an asset under management (AUM) of Rs. 4.11 lakh crore as compared to ELSS which had Rs. 99,817 crore at the end of December 2019. However, although the AUM of ULIPs is ahead of ELSS in terms of absolute growth, it is way behind ELSS in terms of percentage growth in AUM. This is due to higher base of ULIPs. The following graph would help you to understand this better. 

The above graph makes it clear that in terms of AUM growth in percentage terms, ELSS is way ahead than ULIP. In fact, ULIP has witnessed a negative growth even when the markets (Sensex) were surging. This scenario can be seen in the year 2016 when the markets grew by around 2 per cent while the AUM growth of ELSS grew around 22 per cent and the AUM growth of ULIP fell by 6 per cent. However, the insurance company is really good at pitching products. In fact, it has the best sales team ever. The sales team perfectly understands a potential customer’s behavioural bias and uses it to sell its products. It is a no brainer about why they pitch more of ULIP than any other insurance product. It’s all to do with commissions! This is the sole motivation.

Not to forget that ULIPs are a bit easier to sell than ELSS. Why so? Because they have insurance embedded in it. Hence, the insurance sales team just has to say those three magical words – insurance, tax benefits and returns – to get a client to sign on the dotted line. These factors have helped them gain a lot of clients and their confidence. Despite all these things, does ULIP stand as strong as against ELSS? We shall find out. However, for all those who are new to this game, the following paragraphs will explain in detail the difference between ULIPs and ELSS.

Defining ULIPs
ULIPs are products that are supposed to give you the benefit of both worlds, i.e. protection in terms of insurance and investment by investing in the equity markets. Here the policyholder pays a premium of which a small portion goes towards securing your life with the help of insurance cover and the remaining amount is invested just like mutual funds. 

However, there are various costs involved in ULIPs which we would discuss in the later part of the story. For now, ULIPs are more like mutual funds with insurance cover. Just like a mutual fund, ULIP also has different fund categories such as large-cap, small-cap, mid-cap and multi-cap.

Defining ELSS
Equity-Linked Saving Scheme, popularly known as ELSS, is a tax saving investment product with an objective to seek capital appreciation by investing in equity and equity-related instruments. Just like a multi-cap fund it has no restrictions with respect to market-cap. It is free to invest in companies with different market-cap in desired proportions. Although, it is observed that a maximum portion of its assets are usually dedicated towards the top 200 companies in terms of marketcap. ELSS is a more efficient tax saving product for investors with moderate to aggressive risk profile. 

Performance
Performance is one of the criteria that people often look to base their decisions on. Hence, in this part of the article we are going to compare the performance of ULIP and ELSS to understand how they fare with each other. ULIP and ELSS are both structured differently and thus it is important to bring them to a level playing field. So, ELSS just being an investment product, we would only compare the investment part of ULIP, excluding the other charges. For illustration purposes, we have chosen the best and the worst of ULIP and ELSS funds over the past 10 years. Even though all the fund categories of ULIP have the tax benefit factor, we have chosen to go with multi-cap as ELSS is similar to a multi-cap fund. Further, to understand the performance better we have calculated five-year rolling returns for the period February 2010 to January 2020. 

The above five-year rolling returns’ graph clearly shows that at least in terms of performance ELSS beats ULIP. Even the worst-performing ELSS was able to beat the best-performing ULIP. The following table will help you with the other statistical data related to the performance of ULIPs and ELSS. 

Even in terms of risk and returns profile, as measured by Sharpe Ratio, ELSS seems to be a better option. Not to forget that in case of ULIP we have not accounted for various applicable charges in the return’s calculation. On the other hand, the returns of ELSS are net of all the expenses. So, accounting of those charges in ULIP will further reduce its returns. 

Looking at it in terms of trailing returns or in terms of rolling returns, purely in terms of performance, ELSS is way ahead of ULIP. Even the worst-performing ELSS performs better than ULIP.

Cost
Cost is one such factor that people may ignore while making an investment. This is because they are busy focusing on returns. However, cost also matters as it is one of those things that eat up your returns. Therefore, in this section of the article we will concentrate on the cost factor of ULIP and ELSS.

ULIP Costs
ULIP being an insurance product comes with host of charges and fees levied to the insured cum investor. Following are the costs that are involved in ULIP. The list is indeed long but do bear with us!

1. Premium Allocation Charges: Premium allocation charges are the ones that are charged by the insurer prior to allocating the policy. These are the expenses that are incurred by the insurance company while issuing the policy. Fees such as underwriting cost, medical expenses, agent’s commission, etc. form the part of premium allocation charges. Once premium allocation charges are deducted from the premium amount, the remaining amount goes towards investment in selected funds. Say, for instance, if the premium allocation charges stand at 20 per cent and the total premium paid is Rs. 1 lakh, then Rs. 20,000 would be deducted as premium allocation charges and Rs. 80,000 would get invested in the opted fund.

2. Administration Charges: The insurer charges this fee for administration of your policy. The fee is charged on a monthly basis by proportionately cancelling the units from each fund that you have selected. It can be same throughout the tenure or may vary at a pre-determined rate.

3. Fund Management Charges: These charges are levied for managing the fund that you have selected. The fee is charged by the insurer as a percentage of the fund’s value and the Net Asset Value (NAV) of ULIP reflects the same. As per the Insurance Regulatory and Development Authority of India (IRDAI) regulations, the fund management charges should not exceed 1.35 per cent.

4. Surrender Charges: Surrender charges are levied if the insured opts to prematurely close the ULIP policy. This means that if you surrender the policy within five years from the date of commencement of the policy then the insurer will levy surrender charges. It is charged as a percentage of the fund value and premium. Going by the IRDAI’s regulations, only the incurred cost of acquisition in the event of discontinuance of policy can be recovered by the insurer. The surrender charges for the first four years may range between Rs. 1,000 to Rs. 3,000 depending upon the premium paid. From the fifth year onwards, no surrender charge is applicable.

5. Partial Withdrawal Charges: Subject to pre-specified conditions, investors are allowed to partially withdraw from ULIP from the third year onwards. However, these withdrawals attract penalty.

6. Mortality Charges: These are charged by the insurer to provide death cover to the insured. The insurer calculates it by factoring in the insured’s age, health and mortality table.

7. Switching Charges: Investors are allowed to perform a switch between different fund options. Only a fixed number of switches are free and any subsequent switch attracts charges that might range from Rs. 100 to Rs. 500 per switch depending upon the insurer.

ELSS Costs
Compared to ULIP, the cost involved in ELSS is less. Following are some of the charges levied under ELSS:

1. Base TER:  An actively managed fund’s base total expense ratio (TER) includes the fund management charges, commissions to the distributor, administrative charges, etc. The average base TER of ELSS as on January 2020 for a regular plan is 1.98 per cent and for a direct plan is 1.08 per cent. The difference of 0.9 per cent between the regular plan and direct plan is the commission offered to mutual fund distributors.

2. Additional Expenses: As per Regulation 52 (6A) (b) and 52 (6A) (c), mutual funds can charge additional 30 basis points expenses if 30 per cent of gross inflows or 15 per cent of year-to-date average AUM is from B 30 cities. This only forms the part of the TER for regular plans. The average additional expenses for ELSS amount to 0.08 per cent.

It is to be noted that the NAV of ELSS accounts for all the expenses listed above. That is not the case with ULIP. ULIP only accounts for fund management charges. Hence, the actual returns earned by the ULIP investor might be lower to the extent of expenses not accounted for in NAV.

Liquidity and Flexibility
Apart from costs, liquidity and ease of access to money is also an important factor. Both ULIP and ELSS come with a lock-in period. But the lock-in period for ULIP is five years and that of ELSS is three years. So, from a bird’s eye view, clearly ELSS goes ahead of ULIP in terms of liquidity. Now, let us look at it in micro terms. In ELSS, you are not allowed to make any withdrawals during the lock-in period. On the other hand, you are allowed to make partial withdrawals in ULIP. But there is a catch! You are allowed to make partial withdrawal only after three years from the date of commencement of the policy and that too would attract charges. 

So, in terms of liquidity, clearly ELSS goes ahead of ULIP. You can withdraw complete investment from ELSS after three years. However, you need to note that the lock-in period applies to each Systematic Investment Plan (SIP) done in ELSS. This means that SIP done in April 2019 can be withdrawn after March 2022. SIP done in May 2019 can be withdrawn after April 2022, so on and so forth. When it comes to flexibility, ULIP has some amount of flexibility. In ULIP, you can switch from one fund to other with a fixed number of free switches allowed. Any additional switch would attract switching charges. However, any such facility is not available in ELSS.

Conclusion
Saving taxes have been one of the most crucial activities for many people. In fact, some don’t even think twice before buying a depreciable asset, but seek 100 ways to not pay tax. However, there are people who truly save tax keeping their financial goals in mind. So, it is important to choose the right product that would not just help you to save tax but also help you to achieve your financial goals. From this article we can conclude that ELSS in all ways is a more efficient product for tax saving compared to ULIP. May it be in terms of performance or cost or even liquidity, ELSS treks ahead of ULIP. One thing that is available in ULIP but not available in ELSS is life insurance cover. However, that is not a big deal as you can take a term insurance policy to cover your life. The only benefit that ULIP has above ELSS is its tax status. ULIP enjoys ‘exempt-exemptexempt’ (EEE) tax status. However, in case of ELSS, any long-term gains above Rs. 1 lakh are taxed at 10 per cent. Even then, looking at the performance of ELSS, the tax doesn’t seem to be a demoralising factor. Hence, opting for ELSS certainly makes more sense!