ELSS vs ULIP Comparison of ELSS Funds with Unit Linked Insurance Plans

Equity-Linked Savings Schemes (ELSS) and Unit-Linked Insurance Plans (ULIP) both are popular investment options to get tax benefits under Section 80C of Income Tax Act, but they both are differ significantly in terms of their structure, investment objectives, and Nature.

To choose between the two, you must align your financial objective and goals to the schemes and select the one that suits you the best. Below is a comprehensive comparison of ULIPs vs ELSS, covering their key features, advantages, and disadvantages.

What is an Equity Linked Savings Scheme (ELSS)?

ELSS is a diversified, equity mutual fund. The scheme invests in the capital market and selects companies with different market capitalizations. In a financial year, an investor can claim a tax deduction of up to Rs 1,50,000 against investments made in ELSS. These investments have a mandatory lock-in period of three years from the time of investing.

Things to Know About ELSS

• You are free to invest any amount in an ELSS. However, for tax deductions, contributions of only up to Rs 1,50,000 will be considered.
• ELSS is the best tax-saving investment option and offers the dual benefit of tax deductions and the potential to earn higher returns with a short lock-in period.
• The returns on ELSS are not tax-exempt.
• You can continue to invest in this scheme even after the completion of the mandatory lock-in period of three years.
• The risk involved with ELSS is higher when compared to a fixed deposit or a PPF, but the returns are potentially higher as well.

What is Unit Linked Insurance Plan (ULIP)?

ULIP is an investment plus insurance product where one part of the investment is used for ensuring the investor, while the other part is invested in the products of his/her choice. 

Investors can choose to invest in equity, debt, hybrid, or money market funds through ULIPs. Of the amount invested in ULIPs, a contribution of up to Rs 150,000 can be claimed as the tax deduction under Section 80C of the Income Tax Act.

These investments have a lock-in of five years. An investor can choose to switch from equity to debt or hybrid as per their investment objective during the lifecycle of the investment.  

Things to Know About ULIP

• ULIPs offer both protection in the form of an insurance policy and the power of an investment. This sets ULIPs apart from other traditional investment policies.
• In the initial years, the premium of the ULIP payment goes towards meeting one’s insurance needs and policy expenses.
• Post these deductions; the premium is divided between providing you with a life cover and buying fund units for investment.
• The expenses involved in ULIP investment includes premium allocation charges, administration charges, mortality charges and fund management charges.

Nature of Investment

ULIP 

• ULIP is a hybrid product that comes with the combination of both the life insurance with investment. Part of the premium is allocated towards providing life insurance coverage, while the rest is invested in market-linked instruments like equity, debt, or a mix of both. 

ELSS

• ELSS is a type of mutual fund that invests primarily in equity and debt, offering exposure to the stock market without any insurance coverage. It is a purely investment-oriented product.

• ULIP:
  • In ULIP you can avail Tax deductions under Section 80C for premiums up to ₹1.5 lakh.
  • Maturity benefits are tax-exempt under Section 10(10D), provided the annual premium does not exceed ₹2.5 lakh. However, if the premium exceeds this amount, the maturity amount is taxable.
• ELSS:
  • You can avail tax deduction under Section 80C for investments made in ELSS within a financial year up to ₹1.5 lakh.
  • LTCG Long-term Capital Gains tax of 12.5% is applicable if the gains exceed ₹1 lakh in a financial year.

Charges

• ULIP:
  • ULIP’s having Higher charges, which includes premium allocation charges, mortality charges, policy administration charges, and fund management fees.
  • Charges can be significant, especially in the first few years.
• ELSS:
  • Relatively lower charges as compared to ULIP’s, while most of the fund management fees less than 2.5% annually even though if you consider the regular funds.

Lock-in Period 

• ULIP:
  • ULIP’s are Typically having a 5-year lock-in period, meaning you cannot access the funds before the completion of 5 years.
• ELSS
  • ELSS having shorter 3-year lock-in period, offering more flexibility and liquidity after this period.

Liquidity

• ULIP
  • ULIP’s are liquidable After the 5-year lock-in, you can surrender the policy or partially withdraw the funds but early exits before 5 years may attract surrender charges.
• ELSS
  • ELSS More liquidable, as the fund can be redeemed or sold after the 3-year lock-in period without significant penalties, though early withdrawals may incur an exit load.

Returns

• ULIP:
  • Returns in the ULIP’s are totally depend on the funds where they invest in equity, debt, or balanced. They are generally lower than ELSS because part of the premium is used for life insurance coverage and various charges which leads to reduce returns.
• ELSS:
  • Typically offers higher returns due to its equity exposure, with the potential for long-term growth. The returns are market-linked, and you can expect 10%–12% returns on average, but with higher risk.

Risk Factor

• ULIP:
  •  Being a mix of insurance and investment, it carries market risk like equity investments, but the insurance element adds a layer of risk mitigation.
• ELSS:
  • Purely an investment product, so the market risk is entirely on the investor. It can offer high returns during good market conditions but is also exposed to market fluctuations.

Flexibility

• ULIP:  
  • Offers more flexibility with the ability to switch between funds (equity, debt, or a mix) based on your risk appetite and financial goals.
• ELSS:
  • Does not provide the same flexibility. Once you choose an ELSS fund, you need to stay invested in that scheme for the entire lock-in period.

Purpose

• ULIP:
  • Designed as a dual-purpose product offering both life insurance and investment. It’s a good option if you want both insurance coverage and market-linked returns in one product.
• ELSS:
  • Primarily an investment product, best for investors who want to maximize returns through equity exposure and gain tax benefits.

Taxation on Returns

• ULIP:
  • Returns are tax-free under Section 10(10D) if the policy premiums are below ₹2.5 lakh. If the premium exceeds this threshold, the returns are taxed according to the investor’s income tax slab.
• ELSS:
  • Long-term capital gains (LTCG) above ₹1 lakh are taxed at 10% without the benefit of indexation. Short-term capital gains (STCG) are taxed at 15%.

Summary Comparison: ULIP vs ELSS

Conclusion

• Consider ULIP when you want a combination of life insurance and investment while comfortable with higher charges and a longer lock-in period.
• Consider ELSS when you're looking for a pure investment option that offers higher potential returns, lower charges, and a shorter lock-in period

It’s crucial to evaluate your financial goals, risk tolerance, and investment horizon before choosing between ULIPs and ELSS. You might also want to consult a financial advisor to make an informed decision based on your needs.