While everyone says ULIP is tax free, what is the reality? Read this detailed illustrated post to know that why investing in ULIP could be a nightmare. Ever since it was announced that there will a long-term capital gain tax of 10% on all equity gains arising from direct equity or mutual funds, almost every fund house is trying to sell ULIP to investors. The reasoning made by agents is – returns from ULIP are tax free! But, what is the reality? Let us see do reality check – Mutual Funds Vs ULIPs.
I did some basic calculations, assumed that underlying ULIP would yield only 8% of CAGR as insurance illustration do not allow to beyond 8%. I considered Mutual Fund investment CAGR of 10%.
Why the difference of 2%?
For one main reason – ULIPs are closed ended investment products, and they have no obligation to keep on reporting rising performance year after year. Once you buy the product, you cannot exit at your will.
However, mutual funds have kind of unofficial obligation to keep performance at a certain level so that investors stay invested. So, a 2% difference is very fair. While, mutual funds have delivered a staggering 13-15% CAGR, I have not considered this for reasons mentioned above.
So, you can calculate for yourself what will happen to your returns in mutual funds if you consider CAGR of 12%.
So, here is the detailed explanation –
- I have assumed we are investing lumpsum amount of 20 lac. INR.
- As insurance/term cover is part of ULIP, I made a provision separately for an option when investment is made into Mutual Funds
- Value at the end of 20 yrs is calculated based on the CAGR mentioned above
What ULIP companies/agents never tell you?
Not all ULIPs are tax free, and companies/agents selling ULIPs will never tell you this.
Returns from ULIP are tax free only if – The sum insured is 10 times of the premium paid.
So, if you are paying ULIP premium of 20,000 INR per year, and if your sum insured is not more than or equal to 20 lac. INR, then the returns from your investments will be taxed as per your tax slab.
Many companies do not have ULIP plans that option to buy a cover that exceeds 10 times the premium paid. And this is not shared with investors at the time of selling ULIP. Nobody knows where will that agent be after 20 yrs? You will have to deal with extremely rigid financial companies who would through finance jargons at you if you try to content their low return or taxability claims. The only choice you have left is take whatever you can and just exit.
Why Mutual Funds are still better investment options?
Mutual funds are actively managed, and they are open ended. That means they not only have to get a customer, to ensure that customer stays with them for longer duration. For ULIP, the job is done the moment you buy the product and you are forced to stay invested.
Mutual funds have transparent fee structure. All ratios such as expense ratio, LTGC % etc are known in advance. It is another matter if your advisor is not updating you with these numbers, but from a product perspective, mutual funds are really transparent.
You have a freedom of exit from a fund if it is not performing at your expectations. You can exit the next day or the next year, choice is yours.
So, in a nutshell, if your intention is only to avoid 10% LTCG tax, then it is foolish to buy any other product that is disguised as tax beneficiary. It is foolish to be investing forcefully and not have exit choice.
I, personally, would not mind paying 10% LTCG on 1.5cr than just make 93 lac tax free gains from ULIP. Even after paying 10% LTCG, I will still have 61% more returns from investing in mutual funds.