ELSS vs. ULIP: A Detailed Guide on Which Investment Choice is Better

While a consistent monthly salary is a great way to handle your expenses, additional income is necessary to take care of your bigger goals, such as annual vacations, buying an automobile, investing in your children’s future, etc. This is where investing instruments such as mutual funds, bonds, securities, etc. come into play. Since a plethora of investment options are available these days, it can be hard to choose the most beneficial ones from them. Today, we would like to introduce you to two of these instruments, which are known as ELSS and ULIP. Let us take a closer look at their characteristics and compare them to learn about their benefits.

What is ELSS?

ELSS is short for “Equity Linked Savings Scheme,” which is a diversified equity scheme that comes with a minimum 3-year lock-in period. This type of mutual fund invests a high percentage of its corpus in equity-based securities. This scheme is eligible for tax deductions thanks to Section 80C of the Tax Act. They are known as “tax-saving funds” due to their useful tax deductions. Once the lock-in period has been completed, they can either be reinvested or you can exit the scheme after selling your shares.

Most ELSS funds allow you to invest in a diverse range of companies ranging from small-cap to large-cap, amongst other sectors. You can make investments for as little as Rs. 500. Most ELSS schemes offer two types of investment options – SIP and lumpsum. Lumpsum is great for receiving higher returns in a shorter period of time, say 3 years. However, the SIP (Systematic Investment Plan) allows you to invest smaller amounts and reap better tax benefits.

What is ULIP?

ULIP is short for Unit Linked Insurance Plan that offers the duality of working both as an insurance policy and as a life cover. You can fulfill your lifelong goals, as well as protect your family in case of an emergency. One part of the premium paid towards an ULIP goes towards your life insurance contribution, whereas the remaining premium is invested in funds of your choosing, whether they are equity, debt, or a combination of both types of funds. 

To choose a convenient ULIP plan, you must choose the right insurance coverage amount. Additionally, you can adjust the amount between different funds in a scheme to ensure maximum benefits.

ELSS vs. ULIP: Which is better?

1. ELSS strives to build your corpus, like most equity fund-based investments. On the other hand, ULIP provide life coverage and some capital appreciation to investors. While one is purely an investment instrument, the other combines policies from investment and insurance schemes.
2. ULIPs are less risky than ELSS since a policy coverage guarantee is assured even if funds are not returned. However, ELSS is a more high-risk instrument as it allocates a majority of the fund to equity funds. ULIPs take the upper hand in this round.
3. Although ELSS is high-risk, the returns are also greater than those of ULIPs, since the entire premium is used to buy fund units. ULIPs provide lesser returns on average, but they tend to be more stable. 
4. Since ELSS has a lock-in period of only 3 years, it offers more liquidity than a ULIP, which has a minimum tenure of 5 years. Both tax-saving instruments do not have any options for premature withdrawal, so ELSS comes out on top.
5. Although both are tax-exempt up to a certain amount, they are taxable once they are redeemed after their lock-in periods are over. However, ELSS is taxed like regular equity-based funds, whereas ULIP is tax-free for up to Rs. 2.5 lakh. They are thereafter taxed at 15% for short-term profits and 10% for long-term gains. ULIPs take the win in this section. 
6. One underrated aspect of these funds is the expense ratio, which is basically the percentage of returns that need to be paid as a fee for managing your funds. ELSS has a lower expense ratio. For example, the typical large-cap fund has an expense ratio of 0.5–1.5%. But for the typical ULIP scheme, the expense ratio hovers between 1.05 and 2.25%. ELSS wins here by a clear margin.

Advantages of ELSS

• Higher revenue is received once the funds are withdrawn. It can also be reinvested for further returns.
• Despite their higher profit margins, they are useful for receiving tax deductions.
• ELSS has a lower expense ratio compared to ULIP. The expense ratio is the percentage of returns paid as a fee for fund management. Thus, investing in ELSS offers you a higher percentage of profits.

Advantages of ULIP

• Returns are tax-free up to Rs 2.5 lakh, with some taxation on any further gains.
• A low-risk instrument, especially if the investment portfolio includes plenty of debt instruments. Therefore, the returns do not fluctuate too much based on market volatility.
• Since it is an insurance instrument, investors have the freedom to choose which funds they want to invest in. They can also switch to a different set of funds later. 

Conclusion

Both ELSS and ULIP are useful investments for helping you achieve your financial goals. However, they have a different set of properties and uses that can be useful to you depending on both your short and long-term plans. As always, check out the schemes carefully before making any investments to receive the best possible returns. To know more about the different kinds of investment schemes and their benefits, we suggest taking a look at the Piramal Finance blog.