ELSS vs ULIP - Understand the Difference

Here is everything you need to know about the differences between ULIP and ELSS, and their respective benefits.
ELSS vs ULIP - Understand the Difference
4 mins read
14 Mar 2024

Investing in mutual funds and other schemes is a popular way to grow wealth in India. Two of the most popular types of investment schemes are Equity-Linked Savings Scheme (ELSS) and Unit-Linked Insurance Plan (ULIP). While both of these investment options are eligible for tax deductions under Section 80C of the Income Tax Act, they differ in terms of charges, liquidity, returns, lock-in period, and tax treatment. In this article, we will explore the differences between ELSS and ULIP and help you make an informed decision.

What is ULIP?

ULIP is a combination of insurance and investment. ULIP plans allocate premiums to investments in equity instruments, debt instruments, money market instruments, government securities, bonds, and similar financial instruments. A part of money is used to protect the investor and the rest is invested in the products of his/her choice. The lock-in period for ULIPs is five years.

ULIP features and advantages

ULIP features the following advantages:

  • Combined insurance and investment: ULIPs merge life insurance coverage with investment opportunities, enabling individuals to secure their future while participating in market growth.
  • Flexibility and management: ULIPs grant policyholders control over premium payments and fund switches. They can select from diverse fund options to suit their risk appetite and investment goals.
  • Tax advantages: Like ELSS, ULIP investments qualify for tax benefits under Section 80C of the Income Tax Act.

ULIP investment considerations

Fees and charges: ULIPs may encompass various fees such as premium allocation charges, policy administration charges, fund management charges, and mortality charges. Investors should thoroughly comprehend these charges before committing.

Lock-in period: ULIPs entail a five-year lock-in period, restricting fund withdrawals during this duration, promoting a long-term investment outlook

Disadvantages of ULIPs

ULIPs have a following set of disadvantages:

  1. High charges: ULIPs often come with various charges, including premium allocation charges, policy administration charges, and fund management charges, which can significantly reduce returns.
  2. Complex structure: Understanding ULIPs can be challenging due to their combination of insurance and investment components, leading to confusion among investors.
  3. Limited flexibility: ULIPs may have restrictions on switching between funds or altering premium payment terms, limiting investors' flexibility.
  4. Surrender charges: Exiting a ULIP prematurely may result in surrender charges, which can erode a significant portion of the accumulated funds.
  5. Market risk: ULIPs are subject to market fluctuations, meaning the value of investments can fluctuate based on market performance, exposing investors to market risks.
  6. Extended lock-in period: The five-year lock-in period of ULIPs may not align with the preferences of investors seeking greater liquidity.

What is ELSS?

ELSS is a diversified equity mutual fund. The scheme invests in the capital market and select companies with different market capitalisations. ELSS funds come with a mandatory lock-in period of three years.

ELSS key features and advantages

ELSS mutual fund features may advantages as follows:

  • Tax advantages: ELSS offers tax deductions up to Rs. 1.5 lakh under Section 80C of the Income Tax Act, effectively reducing taxable income.
  • Potential for enhanced returns: Being equity-oriented, ELSS holds potential for higher returns compared to traditional tax-saving avenues like FDs or PPF.
  • Three-year lock-in: ELSS comes with a compulsory lock-in period of three years, the shortest among tax-saving options.

Things to consider before investing in ELSS

Market volatility: ELSS investments are susceptible to market fluctuations, impacting the investment's value.

Mandatory lock-in: ELSS funds necessitate investors to stay invested for the entire three-year lock-in period.

Disadvantages of ELSS

Despite their benefits, ELSS funds also come with certain drawbacks that investors should consider before investing:

  1. Market volatility: ELSS funds invest primarily in equities, making them susceptible to market fluctuations and exposing investors to higher risk levels.
  2. Lock-in period: ELSS funds have a mandatory lock-in period of three years, limiting liquidity and flexibility compared to other investment options.
  3. Lack of guaranteed returns: Unlike some other tax-saving investments like Fixed Deposits (FDs) or Public Provident Fund (PPF), ELSS funds do not offer guaranteed returns, making them subject to market risks.
  4. Potential for losses: Due to their exposure to the stock market, ELSS funds carry the risk of capital loss if the market performs poorly during the investment period.
  5. Tax implications on returns: While ELSS funds offer tax benefits on investments, returns generated from these funds are subject to long-term capital gains tax if they exceed Rs. 1 lakh in a financial year.

Differences between ULIP and ELSS

  • Charges
    ULIPs have higher charges than ELSS. The charges in ULIPs include premium allocation charges, policy administration charges, mortality charges, fund management charges, and surrender charges. On the other hand, ELSS has lower charges as compared to ULIPs. ELSS have expense ratio charges.
  • Liquidity
    ELSS has higher liquidity than ULIPs. ELSS has a lock-in period of three years, while ULIPs have a lock-in period of five years. After the lock-in period, investors can withdraw their money from ELSS without any penalty. However, in ULIPs, if an investor surrenders the policy before the lock-in period, he/she may have to pay surrender charges.
  • Returns
    ELSS has the potential to generate higher returns than ULIPs, because ELSS invests in equity, which has the potential to generate higher returns in the long run. On the other hand, ULIPs invests in both equity and debt instruments like money market instruments, government securities, bonds, and similar financial instruments, which may not generate higher returns as compared to ELSS.
  • Tax treatment - ULIP vs. ELSS
    Both ULIPs and ELSS are eligible for tax deductions under Section 80C of the Income Tax Act. Investors can claim tax deduction of up to Rs. 1,50,000 against ELSS investments. On the other hand, a contribution of up to Rs. 1,50,000 can be claimed as a tax deduction under Section 80C: the returns are totally exempted from tax U/S 10(10D) of the Income Tax Act against ULIPs. However, if the insurance premium exceeds Rs. 2.5 lakh for any of the previous years, then the amount received at the time of maturity is taxable.

Comparative analysis of ULIP vs. ELSS

Parameters ULIP ELSS
Charges Higher Lower
Liquidity Lower Higher
Returns Lower Higher
Lock-in period 5 years 3 years

Is ULIP a good investment?

ULIPs are a good investment option for those who want to combine insurance and investment. ULIPs offer financial security in the form of an insurance policy as well as savings growth. ULIPs are a great tax-saving option and offer the dual benefit of tax deductions and the potential to earn higher returns with a short lock-in period. However, the risk involved with ULIPs is higher when compared to a fixed deposit or a PPF.

Is ELSS a good investment?

ELSS is a good investment option for those who want to invest in equity and aim to generate higher returns in the long run. ELSS offers savings on tax as well, along with the potential to earn higher returns with a short lock-in period. However, the risk involved with ELSS is also higher, when viewed against a fixed deposit or a PPF.

Conclusion

In conclusion, both ULIPs and ELSS are good investment options, for investors who wish to invest in the long-term, and are okay with a lengthy lock-in period of 3-5 years. Before investing, research each product carefully and speak to a qualified financial advisor.

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Frequently asked questions

What is the full form of ELSS?

The full form of ELSS is Equity Linked Savings Scheme.

What is the full form of ULIP?

The full form of ULIP is Unit Linked Insurance Plan.

Can I withdraw ELSS before 3 years?

No, ELSS comes with a lock-in period of 3 years.

Is ELSS better than PPF?

ELSS may be better than PPF for some investors, depending on their risk appetite, investment horizon, and tax situation. ELSS has the potential to offer higher returns than PPF, as it invests in equity markets. However, it also comes with higher risk and volatility. PPF gives you guaranteed tax-free returns, but it has a much longer lock-in period of 15 years.

Is ULIP a mutual fund?

ULIP is not a mutual fund. ULIP is a financial product that offers both insurance and investment, while mutual fund is a collective investment scheme that pools money from investors and invests in various securities.

Is ULIP better than mutual funds?

ULIP may be better than mutual funds for some investors, depending on their financial goals, risk profile, and tax bracket. ULIP gives you insurance protection, tax benefits, loyalty rewards, and switching options. However, ULIP also has higher charges, lower transparency, and a long lock-in period.
Mutual funds have more flexibility, diversification, and performance. However, they have no insurance cover and carry a tax liability on returns.

ULIP or ELSS, which is better?

Choosing between ULIP and ELSS depends on your financial goals and risk tolerance. ULIPs offer insurance coverage with investment, while ELSS provides tax benefits with equity investment.

Are ULIP returns taxable?

Yes, ULIP returns are subject to tax. However, the maturity proceeds of ULIPs are tax-free under Section 10(10D) of the Income Tax Act, subject to certain conditions.

What is the difference between a mutual fund and a ULIP?

A mutual fund is a pure investment vehicle, while a ULIP combines investment with insurance. ULIPs offer life cover, whereas mutual funds do not have an insurance component.

Can ULIPs give higher returns?

ULIP returns depend on market performance and the chosen fund's performance. While ULIPs have the potential to offer higher returns due to their equity exposure, they also carry market risks.

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