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Are ULIPs a costly form of term insurance plus MF investments?

This article compares Unit Linked Insurance Plan (ULIP) with a combination of term insurance & Equity Linked Savings Scheme (ELSS) investment, and judges the utility of each strategy. (ULIP versus Mutual Funds – MF)

 

What we have learnt so far

In “ULIP v/s Endowment Plan for Life Insurance“, we saw that Unit Linked Insurance Plans (ULIPs) are better than traditional endowment plans. But then, in ““Term policy” is the best policy“, we discussed that investments should be separated from insurance, and therefore, we concluded that term plans are the best form of insurance.

So, here, let’s see how the benefit of Unit Linked Insurance Plans (ULIPs) can be achieved (and bettered!!) using a combination of Term Insurance and Equity Linked Savings Scheme (ELSS) mutual fund (MF).

Let’s recap the benefits of Unit Linked Insurance Plans (ULIPs):

  1. Flexibility to choose the type of investment scheme – Mostly equity, mostly debt, and various combinations in-between
  2. Transparency – You know where your investments are being made, and you know the charges incurred by you

(For more details, please read “ULIP v/s Endowment Plan for Life Insurance“)

 

How are we going to compare the two?

Here is what we are going to do: First option is to buy insurance using a ULIP. The second option is to buy insurance using a term plan, and since term insurance is a lot cheaper than ULIPs, invest the difference in the premiums in ELSS.

Let’s walk through a real-life example and see how both these options compare.

Here is a comparison of charges for a ULIP and a term plan for a sum assured of Rs. 10 Lakhs for a 30 year old male (Policy term is 25 years):

Insurance Company SBI Life SBI Life
Scheme Name SBI Horizon II (ULIP) SBI Shield (Term Plan)
Premium (Per Year) Rs. 80,000 Rs. 2,963

 

Thus, for our option B (combination of Term Insurance and ELSS), we would invest the difference – Rs. 77,037 per year – in an ELSS.

 

Fees charged by ULIPs and MF ELSS Schemes

ULIPs charge a fee, called “Premium Allocation Charge” every year. Generally, this fee is very high in the initial 2-3 years, and goes down for subsequent years. Apart from this, ULIPs also charge a yearly “Fund Management Fee”, just like mutual funds. (The names for these fees may differ a little among fund houses). These fees are charged as a percentage of money invested.

For the ULIP in our example, the Fund Management Fee is 1.5%, and the “Premium Allocation Charge” is as follows:

Year 1 15%
Years 2 and 3 10%
Year 4 onwards 5%

 

As you can see, the charge is the maximum in the initial years. This is the biggest disadvantage of ULIPs – since the investment is for a very long term, the higher fee in the initial years has a huge impact on your final returns due to the compounding effect. (We would see it illustrated in our example)

The premium of a ULIP is broken down into two components. The first is the “Mortality Charge”, which is the amount for insuring your life. The second is the remaining amount, which is invested in the option you choose.

Let’s say that the mortality charge for the ULIP is also Rs. 2,963. Thus, the amount remaining for investment is also Rs. Rs. 77,037 per year. If we deduct the “Premium Allocation Charge” and the “Fund Management Fee”, the amount remaining for investment is:

Year 1 Rs. 64,499
Years 2 and 3 Rs. 68,293
Year 4 onwards Rs. 72,087

 

On an average, ELSS schemes have a fund management fee of 2%. Thus, amount actually invested would be Rs. 75,496 per year in the case of ELSS.

 

Comparison of the returns

The following table compares the returns generated by our two options, if we assume the rate of return to be 12% per year for both these:

Login Required Download the spreadsheet for the calculations

 

ULIP ELSS
Amount
Invested
Cumulative
value of investments
Amount
Invested
Cumulative
value of investments
Year 1 64499 72239 75496 84556
Year 2 68293 157396 75496 179258
Year 3 68293 252772 75496 285325
Year 4 72087 363843 75496 404120
Year 5 72087 488242 75496 537170
Year 6 72087 627569 75496 686186
Year 7 72087 783615 75496 853085
Year 8 72087 958387 75496 1040011
Year 9 72087 1154131 75496 1249368
Year 10 72087 1373364 75496 1483848
Year 11 72087 1618906 75496 1746465
Year 12 72087 1893913 75496 2040597
Year 13 72087 2201920 75496 2370024
Year 14 72087 2546888 75496 2738983
Year 15 72087 2933253 75496 3152217
Year 16 72087 3365981 75496 3615038
Year 17 72087 3850636 75496 4133399
Year 18 72087 4393451 75496 4713962
Year 19 72087 5001402 75496 5364194
Year 20 72087 5682309 75496 6092453
Year 21 72087 6444924 75496 6908103
Year 22 72087 7299052 75496 7821631
Year 23 72087 8255676 75496 8844783
Year 24 72087 9327095 75496 9990712
Year 25 72087 10527085 75496 11274154

 

What do we see? At the end of 25 years, ULIP returns Rs. 1,05,27,085, whereas ELSS returns Rs. 1,12,74,154. There is a net gain of Rs. 7.47 Lakhs!! This, when the insurance cover for both the schemes is the same!

 

There’s more…

But that’s not all – it can get even better. With ULIPs, your investment options are limited to the 4-5 schemes offered by your insurance company. Whereas in ELSS, you have a wide choice among fund houses, and you can switch between them if you feel your investment is not giving adequate returns.

Thus, although we have assumed the return to be the same of ULIP and ELSS, the return for ELSS can definitely be better. Even if it is 13%, the returns would be as follows:

Login Required Download the spreadsheet for the calculations

ULIP ELSS
Amount
Invested
Cumulative
value of investments
Amount
Invested
Cumulative
value of investments
Year 1 64499 72239 75496 85311
Year 2 68293 157396 75496 181712
Year 3 68293 252772 75496 290645
Year 4 72087 363843 75496 413740
Year 5 72087 488242 75496 552837
Year 6 72087 627569 75496 710016
Year 7 72087 783615 75496 887629
Year 8 72087 958387 75496 1088332
Year 9 72087 1154131 75496 1315126
Year 10 72087 1373364 75496 1571403
Year 11 72087 1618906 75496 1860996
Year 12 72087 1893913 75496 2188237
Year 13 72087 2201920 75496 2558018
Year 14 72087 2546888 75496 2975871
Year 15 72087 2933253 75496 3448045
Year 16 72087 3365981 75496 3981602
Year 17 72087 3850636 75496 4584521
Year 18 72087 4393451 75496 5265819
Year 19 72087 5001402 75496 6035687
Year 20 72087 5682309 75496 6905637
Year 21 72087 6444924 75496 7888680
Year 22 72087 7299052 75496 8999519
Year 23 72087 8255676 75496 10254768
Year 24 72087 9327095 75496 11673198
Year 25 72087 10527085 75496 13276025

 

We see that the return generated by ELSS is Rs. 1,32,76,025 – this is around Rs. 27.5 Lakhs more than the Unit Linked Insurance Plan (ULIP)! The best part about this is that this is a very likely scenario, as you would have the most flexibility to invest your funds while using Equity Linked Savings Scheme (ELSS).

 

Income Tax Treatment

The full amount invested in a Unit Linked Insurance Plan (ULIP) is eligible for Section 80C benefit. The full amount invested in an Equity Linked Savings Scheme (ELSS) and the amount spent to buy Term Insurance is also eligible for Section 80C benefit. Thus, both the options – Unit Linked Insurance Plans (ULIPs) and a combination of Term Insurance and Equity Linked Savings Scheme (ELSS) mutual fund (MF) – have the same tax implication, and there would be no impact on the returns even if we consider income tax.

 

Conclusion

The combination of Term Insurance and Equity Linked Savings Scheme (ELSS) mutual fund (MF) wins hands down as compared to Unit Linked Insurance Plan (ULIP). Following are the benefits:

  • Better returns – The example clearly illustrates why separating investment from insurance makes better financial sense! The potential for superior returns is very high compared to a ULIP.
  • Full flexibility – You can choose not just ANY mutual fund (MF) scheme, but can also switch MF houses. This is IMPOSSIBLE in ULIPs!

As always, there remains one universal condition for getting these superior returns – you need to be disciplined in your investments. You should invest regularly in the ELSS, and you should not withdraw any amount form your corpus before time.

Happy investing!

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