Decoding ULIP vs ELSS: A Comprehensive Financial Analysis

As an investor, you must understand the nuances of various investment options available in the market. This will not only help you plan your finances better but may also make attaining your financial goals easier. Among the many market-linked investment options available, ULIP plans and ELSS mutual funds are two of the most popular choices amongst Indian investors. 

But what exactly are these two investment options and how do they stack up against each other? That’s exactly what we’re going to be looking at in this article. Continue reading for a comprehensive analysis of ULIP vs. ELSS, shedding light on how they work, their various benefits and differences. 

What is a ULIP? 

A ULIP or unit-linked insurance plan is a unique financial product that combines two different elements - insurance and investment - into a single plan. When you make a ULIP investment, you not only get access to life insurance coverage but also get the benefit of wealth creation. 

A portion of the premium you pay towards a unit-linked insurance plan is used to provide a life cover, whereas the remaining premium is invested in market-linked investments of your choice. 

Furthermore, ULIPs have a mandatory lock-in period of five years during which you cannot redeem your investments. However, you may choose to surrender your policy before the expiry of the lock-in. 

How Do ULIP Plans Work? 

Unit-linked insurance plans are offered by life insurance providers. As you’ve already seen, a part of the premiums paid by the policyholders are used by the insurer to provide them with a life cover. 

The remaining portion of the premiums paid by policyholders are pooled together into a common fund. This fund is then invested in a diversified portfolio of assets consisting of equity stocks, debt instruments or a mix of both, depending on the investment option chosen by the policyholders.

If the policyholder dies during the tenure of the ULIP investment, the death benefit chosen by them is paid out to the nominee along with the principal investment and returns that their market-linked instruments generated up until that point. 

ULIP Plans: An Example

Here’s a hypothetical scenario to help you understand how a unit-linked insurance plan works. 

Let’s say that you wish to secure the financial future of your family. You opt to purchase a unit-linked insurance plan since it provides a dual benefit of insurance and investment. At the time of purchase, you select a death benefit sum assured amount of Rs. 50 lakhs. You also choose to invest your premiums in a Nifty 50 index mutual fund. The entire tenure of the ULIP is 10 years. 

Now, based on your choices, you’re required to pay a premium of Rs. 10,000 each month for the next 10 years. Out of the monthly premium of Rs. 10,000, a portion of it, say Rs. 5,000, will be used by the insurance company to provide you with a life cover of Rs. 50 lakhs. The remaining R. 5,000 will be invested in the Nifty 50 index mutual fund. 

In the case of your death during the 10-year tenure of the ULIP investment, the death benefit of Rs. 50 lakhs will be paid to the nominee of your policy. Additionally, the nominee will also receive the entire value of your ULIP (with both the principal and returns) at the time of your death. 

However, if you survive till the end of the 10-year tenure, you will be ineligible to get the death benefit sum assured amount of Rs. 50 lakhs. Instead, you will only be paid the value of your ULIP investment as of the date of maturity. 

What are the Key Benefits of ULIP Plans?

ULIP investments offer a plethora of advantages to policyholders. Understanding what they are is crucial to making informed investment decisions. Here’s a detailed overview of some of the major benefits of this investment option. 

• Financial Protection 

The insurance component of ULIP plans provides financial protection to the nominees or beneficiaries in the event of the policyholder’s death during the tenure of the plan. The death benefit sum assured amount offered by a unit-linked insurance plan can be used by the beneficiaries to meet their financial goals.  

• Potential for Long-Term Wealth Creation 

Since ULIPs invest a portion of the premiums in market-linked investments like equity, debt or both, policyholders get to enjoy the opportunity for wealth creation. That said, to maximise the wealth creation potential, it is crucial to stay invested throughout the entire tenure of the plan. 

• Flexibility 

Unit-linked insurance plans are one of the most flexible market-linked investment options currently available. Policyholders have the freedom to choose the amount of premium they wish to pay and the frequency of the payments. Additionally, they also get the flexibility to switch between different investment funds depending on changes to their risk profile and market conditions. 

• Tax Benefits 

ULIP plans offer a plethora of tax benefits to policyholders. Firstly, the premiums that you pay towards the plan can be claimed as a deduction under section 80C of the Income Tax Act, 1961. The maximum amount of deduction per financial year is limited to Rs. 1.5 lakhs, which can reduce the overall tax liability. 

In addition to this, the death benefit sum assured amount the nominees or beneficiaries receive upon the death of the policyholder is completely tax-free as per section 10(10D) of the Income Tax Act, 1961. 

Furthermore, the maturity benefits that ULIP investments provide are also tax-free as long as they satisfy the following conditions. 

• In the case of plans purchased before April 1, 2012, the annual premium must be less than 20% of the sum assured. 
• In the case of plans purchased between April 1, 2012 and February 1, 2021, the annual premium must be less than 10% of the sum assured. 
• In the case of plans purchased after February 1, 2021, the annual premium must be less than Rs. 2.5 lakhs. 
• Liquidity 

Another major benefit of ULIP investments is the liquidity on offer. Policyholders can partially withdraw their investments or avail of loans against the policy to meet financial emergencies or unforeseen expenses. 

What is ELSS? 

ELSS or equity-linked savings scheme is a special type of mutual fund that pools money from multiple investors and uses it to invest primarily in equities and equity-related instruments. Unlike the other types of mutual funds, ELSS has a lock-in period of three years from the date of the first investment. 

While this lock-in period is active, investors cannot redeem their fund units. The primary objective of ELSS mutual funds is to encourage investors to stay invested for the long term and help them reap the benefits of wealth creation. 

How Do ELSS Mutual Funds Work? 

ELSS mutual funds are offered by asset management companies (AMCs). These funds invest a majority (at least 65%) of their assets in stocks of different companies and other equity-related instruments across sectors, industries and market capitalisations. 

ELSS investments are actively managed by fund managers, who are experienced professionals with decades of experience in the stock market. These fund managers use a variety of different investment strategies to capitalise on market opportunities while simultaneously managing the various risks prudently.

Investors who have invested in ELSS funds cannot withdraw their investments under any circumstances before the expiry of the three-year lock-in period. However, once the lock-in expires, they’re free to either partially or fully redeem their investments. 

ELSS Mutual Funds: An Example 

Let’s now take a look at a hypothetical scenario to understand how ELSS investments work.

Assume you wish to create wealth over the long term and want to save tax simultaneously. You decide to invest a lump sum amount of Rs. 5 lakhs in an equity-linked savings scheme that invests about 80% of its assets in stocks of different companies and other equity-related instruments. 

Let’s say that the date of investment is April 1, 2023. Now, since there’s a three-year lock-in period for ELSS investments, you won’t be able to either partially or completely redeem your units until after April 1, 2026, which is when the lock-in expires. 

What are the Key Benefits of ELSS Mutual Funds?

Similar to ULIPs, ELSS investments also have their fair share of advantages. Let’s look at some of the benefits that investors stand to enjoy by investing in them. 

• Potential for Higher Returns 

ELSS primarily invests in equities and equity-related instruments, which have the potential to deliver higher returns compared to traditional tax-saving instruments. The equity market has historically delivered superior returns over the long term, making ELSS an attractive option for wealth creation.

• Tax Benefits 

The investments that investors make in ELSS can be claimed as a deduction under section 80C of the Income Tax Act, 1961. The maximum amount of deduction that can be claimed per financial year is Rs. 1.5 lakhs. Claiming ELSS investments as a deduction reduces the total taxable income and helps investors save tax.

• Short Lock-In Periods

Compared to other traditional tax-saving investment options like the Public Provident Fund (PPF) and National Savings Certificate (NSC), ELSS mutual funds have the shortest lock-in period. This means that investors can get access to your investments far quicker than other investments. 

• Professional Management 

Equity-linked savings schemes are actively managed by experienced fund managers, who conduct in-depth research and analysis to identify investment opportunities with the potential for long-term wealth creation. 

• Ability to Invest via SIPs 

ELSS funds provide the option of investing via systematic investment plans (SIPs). SIPs allow investors to invest a set amount of money at regular intervals, enabling them to mitigate the impact of market volatility over time.

ULIP Vs. ELSS: The Differences 

Now that you’ve gotten a comprehensive overview of these two investment options, let’s compare ULIP vs. ELSS to see how they differ from one another. 

Conclusion

Both ULIPs and ELSS offer unique advantages and cater to different investor preferences and financial goals. ELSS funds are ideal for risk-aggressive investors looking for high returns on their investment and tax benefits. ULIPs, meanwhile, are only ideal for those investors looking for dual benefits of insurance and investment from the same product. A better alternative may be purchasing insurance as per your requirements and choosing pure investment products to meet your long-term goals.