ELSS vs ULIP – A Comparative Analysis of Tax-Saving Schemes

ELSS and ULIPs are two such products that are often pitted against each other and the debate resurfaces every time in the tax-saving season. Both products come with tax benefits under Section 80C of the Income Tax Act, 1961 and both are a type of investment products. Therefore, the confusion among the investors as to which one is better and a comparison between the two is but natural. Here, we will do a detailed comparative analysis of ELSS vs ULIP to give a better insight to the readers as to what product shall suit them better.

ELSS vs ULIP

We shall compare ELSS and ULIP based on various parameters which can help investors identify the similarities and differences between the two. It will further assist in decision-making as to which among the two plans is better to match their financial goals.

1. Product Type & Feature

The primary difference lies in the type and the basic attribute of both the products where ELSS is solely a mutual fund, unlike ULIP. ULIP is more complex as a combination of both insurance and investment where the money is partially invested in mutual funds. A major point of difference to be noted is that the ULIPs are offered mostly by insurance companies. The insurance company gives the death benefit to the investor where the nominee receives the higher of the sum insured or the value of the mutual fund units in the ULIP. ELSS will give the complete value of the fund as it is at the time of redemption.

2. Investment Objectives

ELSS aims only at corpus building like most of equity funds but it comes with 3-year lock-in tenure. Experts suggest holding the units for a longer period for at least 5-7 years to reap better returns. ULIP aims at providing life coverage to the insurer that can also earn some capital appreciation. ULIP is different from traditional insurance products as they combine insurance and investment.

3. Risks

ELSS is definitely a high-risk investment product as it is a mutual fund scheme that allocates about 65-80% of the fund to equities. ULIPs are comparatively less risky than ELSS because the policy coverage is guaranteed even if the fund returns are not. Also, the ULIP can have equity, debt, or hybrid fund units that also decide the risk factor of the ULIPs. Debt-oriented ULIPs are low in risk and investors can switch from equity to debt funds even during the mid-lifecycle of the ULIP when markets are on a sliding note.

4. Returns

Reiterating the fact that ELSS invests all the money paid by investors to buy fund units whereas the ULIP doesn’t. Therefore, it is natural that ELSS has chances to deliver higher returns than ULIP. Moreover, if the ULIP invests more in debt securities, the returns will be on the lower side than those of equity funds but stable. Let’s explain with an example, if you invest Rs. 10 in ELSS, then you will be allocated units worth Rs. 10. If you invest Rs. 10 in ULIP, then Rs. 5 may go as insurance premium and Rs. 5 for the fund. Most ELSS has a record of giving average returns of 12-14% and ULIPs range from 6-17% depending on the type of fund. It has also been observed that ELSS have generated higher returns than ULIPs not in one off-case but at most times.

5. Tax Computation

Both ELSS and ULIP are tax-exempt up to Rs. 1.5 Lakh in a financial year under Section 80C. However, once the units of ELSS and ULIP are redeemed after their respective lock-in periods of 3 and 5 years, they are subject to tax. ELSS is taxed like the equity funds whereas the ULIP is taxed as per the new norm of the government under 8AD from February 1, 2021. Earlier, the ULIP returns were tax-free under Section 10(10D) but now they are tax-exempt up to Rs. 2.5 Lakh. Thereafter taxed at 10% if the gains are long-term and short-term gains at a 15% flat rate. On the other hand, ELSS returns are tax-exempt up to Rs. 1 Lakh only and taxed at 10% above the prescribed limit.

6. Liquidity

ELSS offers more liquidity than ULIPs because it comes with a shorter lock-in period. In fact, ELSS is often the most preferred choice of investors because, among all tax-saver tools of Section 80C, ELSS has the lowest lock-in time of 3 years only. The lock-in tenure of the ULIP is 5 years and there is no premature withdrawal possible in either ELSS or ULIP. Owing to the shorter lock-in, ELSS offers more liquidity than ULIP.

7. Switching Option

One of the key parameters that differentiate the two products is that the switching option of the asset classes is available with the ULIP. ELSS is necessarily an equity fund and the investors can not opt for a different fund or alternative asset allocation. Whereas ULIP is an insurance product that invests in funds and investors can choose the type of funds they wish to invest in. They can even choose to switch to a different type of fund later on. This provides dual benefits, one that there is a switching option, and second, the investors can invest in a range of funds from equity to bond funds.

8. Expense Ratio

A very important aspect of mutual fund investment is the expense ratio which is charged in percentages. These are charges that fund houses levy for the operations and management of the fund. A higher expense ratio means paying a higher percentage of the returns as a fee for professional management of the fund. This ultimately impacts the returns that come to the investors. ELSS usually has a lower expense ratio than the ULIP ranging from 1.35 to 2.5 whereas ULIP generally starts with an expense ratio of 2.25. ELSS can have management and exit charges and ULIP charges more under several heads other than administration fees. These charges include switching charges, agent commissions, renewal expenses, premium allocation charges, etc.

ELSS comes with predictable costs and understandable returns whereas ULIP lacks transparency where there is no clear picture of cost vs benefit. However, new-age ULIPs are trying to be at par with other funds having lower expense ratios, coupled with loyalty points, wealth boosters, etc. They soften refund mortality charges and remove premium allocation charges and so on.

Wrapping it up:

Both ELSS and ULIP are tax-saving monetary instruments under Section 80C but differ completely in nature of the product. They are also regulated by different regulating bodies of IRDA (Insurance Regulatory and Development Authority) and SEBI (Securities and Exchange Board of India). IRDA regulates ULIP as it is an insurance product with mutual fund benefits and SEBI regulates ELSS that is wholly a mutual fund. ELSS offers transparency as to how the fund operates with no hidden charges whereas ULIP offers flexibility to switch among types of funds during the investment cycle. ELSS and ULIP come with different lock-in periods, taxation rules, and risk-return portfolios.