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ULIP or term insurance plus mutual funds, what’s better?

The big question is whether to buy a ULIP or just a term policy from an insurer? Or in other words, should we separate the insurance needs from that of investment?

Insurers offer a range of products. On the one end is a term plan that offers a pure life cover and acts as an income replacement in case of the untimely death of an earning member in a family. Its entire premium goes towards buying a life cover.

At the other end, Unit Linked Insurance Plans (ULIP) cater to both insurance and investment needs. A part of its premium goes towards buying a life cover while the rest is invested in equity, debt or a combination based on one’s understanding of risk. 

The big question is whether to buy a ULIP or just a term policy from an insurer? Or in other words, should we separate the insurance needs from that of investment?

Let’s compare the two options on the following parameters:

Portfolio performance

Supposing you bought a separate term cover and invested the rest into equity mutual funds. How would it compare with that of ULIP? Past data shows that equity mutual funds on an average have managed to outperform equity portfolios of ULIPs across various categories – large-cap, mid-cap, and multi-cap – as well as across various time horizons (See graph). In each category, mutual fund top performers gave superior returns as compared to their ULIP counterpart.

Mortality cost

Mortality charges are levied for insuring life and are dependent on a number of factors including one’s age and health condition. Usually, insurers refer to a standard table for levying these charges and are the same regardless of whether you buy ULIP or a term cover. 

As per the new IRDA guidelines, a ULIP investor has to buy a minimum cover of seven times the annual premium. So, regardless of whether you already own a life cover or not, you will get additional life cover when you buy an ULIP, without any discounts whatsoever. 

Expense ratio

There are many charges levied to ULIP that make it a costlier proposition than an equity mutual fund. Premium allocation charge is deducted as a fixed percentage directly from the premium paid. Fund management charge in turn is levied for managing various funds while a policy administration charge is levied for the administration of the policy. In addition, there are partial withdrawal charges, switching charges, premium redirection charges, premium discontinuance charges, top-up charges and mortality charges. 

As per regulations, a ULIP provider could annually charge up to 3% of its NAV as expenses for a duration of up to 10 years. In contrast, under mutual fund regulations, an asset management company can charge only a maximum of 2.5% as the total expense ratio for the first Rs. 100 crore of its fund assets and it keeps reducing as the asset size increases.  

Lock-ins

ULIP is available for a tenure of five years or more. And there is a lock-in period of five years during which investors will not be able to liquidate the value of the fund. Discontinuing or surrendering the policy prematurely results in a penalty, while the money is returned only after the lock-in period is over. 

Mutual funds, in turn, have no such lock-in except in case of ELSS funds (of three years). While there are exit loads levied depending on the type of fund, it is very low (about 1%) and applicable only on early exit of one year or so. 

 

Takeaway

It is better to separate the insurance needs from that of investment. Buy a term policy for your insurance needs, while investing in mutual funds to meet your financial goals. 

 

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