When choosing between a unit linked insurance plan (ULIP) and a mutual fund, investors need to assess their financial goals, risk appetite, and investment horizon. While ULIPs combine insurance and investment, mutual funds focus solely on market-linked returns. Each option has its advantages and limitations.
Additionally, investors who need liquidity without redeeming their investments can consider a loan against mutual funds. This option allows them to borrow funds using their mutual fund investments as collateral. Understanding the differences between ULIP vs mutual fund and their respective benefits will help investors make an informed decision.
Understanding ULIPs and mutual funds
What is a ULIP?
A unit linked insurance plan (ULIP) is a financial product that provides both investment and insurance benefits. A portion of the premium paid goes toward life insurance coverage, while the remaining amount is invested in market-linked funds such as equity, debt, or hybrid funds.
ULIPs are flexible, allowing policyholders to switch between different fund types based on market conditions. However, they have a mandatory lock-in period of five years, making them less liquid than mutual funds.
What is a mutual fund?
A mutual fund is an investment vehicle where money from multiple investors is pooled and managed by a professional fund manager. These funds are invested in a diversified portfolio of stocks, bonds, or other securities based on the fund’s objective.
Mutual funds offer high liquidity, and investors can redeem their investments at any time, except for tax-saving mutual funds, which have a three-year lock-in period. Unlike ULIPs, mutual funds do not provide life insurance coverage.
Key differences between ULIPs and mutual funds
| Feature | ULIP | Mutual fund |
| Purpose | Combines insurance and investment | Purely investment-focused |
| Lock-in period | 5 years | No lock-in (except for ELSS funds, which have a 3-year lock-in) |
| Risk factor | Market-linked but with an insurance component | Market-linked with no insurance cover |
| Liquidity | Limited due to lock-in period | Highly liquid, except for tax-saving funds |
| Charges | Multiple charges, including mortality and fund management fees | Only expense ratio (management and operational costs) |
| Tax benefits | Eligible under section 80C and section 10(10D) | ELSS funds qualify under section 80C; other mutual funds are subject to capital gains tax |
| Flexibility | Allows switching between equity, debt, and balanced funds | No switching; investors must redeem and reinvest |
| Returns | Lower due to insurance charges | Higher as the entire amount is invested in market instruments |
Choosing between ULIP and mutual funds based on financial goals
For wealth creation
If the primary goal is to accumulate wealth over time, mutual funds offer better returns due to their direct exposure to market-linked instruments. Equity mutual funds, in particular, have historically delivered higher long-term returns compared to ULIPs, where a portion of the premium is deducted for insurance charges.
For tax-saving investments
Both ULIPs and mutual funds provide tax-saving benefits. ULIP premiums qualify for deductions under section 80C, and maturity proceeds are tax-free under section 10(10D). Meanwhile, ELSS mutual funds offer tax benefits under section 80C but are subject to capital gains tax upon redemption.
For life insurance coverage
If having life insurance coverage is a priority, ULIPs are a better choice as they provide financial protection to the policyholder’s family. Mutual funds do not offer any insurance benefits, so investors would need to buy a separate life insurance policy.
For liquidity needs
Mutual funds offer better liquidity than ULIPs, as investors can redeem their holdings anytime, except in the case of ELSS funds. ULIPs have a mandatory five-year lock-in period, limiting immediate access to funds.
For risk-averse investors
Both ULIPs and mutual funds have varying levels of risk. While equity mutual funds are riskier, debt mutual funds are relatively stable. Similarly, ULIPs allow investment in debt or hybrid funds, but the insurance component and additional charges may reduce overall returns.
Loan against mutual funds: an alternative liquidity option
For investors who need urgent funds but do not want to redeem their mutual fund investments, a loan against mutual funds is a viable option. This facility allows investors to pledge their mutual fund units as collateral and borrow money while continuing to earn potential returns.
Benefits of loan against mutual funds
- Continued investment growth – Unlike redeeming mutual funds, taking a loan ensures that the investment remains intact and continues to grow.
- Instant liquidity – Digital loan processing allows quick access to funds.
- Lower interest rates – Compared to personal loans or credit cards, loans against mutual funds usually have lower interest rates.
- Flexible repayment options – Interest is charged only on the borrowed amount, and repayment terms are adjustable.
How loan against mutual funds works
- The investor pledges mutual fund units as collateral with a lender.
- The lender assigns a credit limit, generally up to 50% of equity mutual fund NAV or 80% of debt mutual fund NAV.
- The investor can withdraw funds as needed while still owning the mutual fund units.
- The loan is repaid in installments or as per the agreed terms, while the mutual fund investment remains active.
Risks associated with loans against mutual funds
While loans against mutual funds offer financial flexibility, they also come with risks:
- Market fluctuations – A decline in mutual fund NAV can affect the collateral value, leading to margin calls.
- Interest costs – Although lower than unsecured loans, interest expenses still apply.
- Limited eligibility – Only select mutual funds qualify for this type of loan.
Pros and cons of ULIPs and mutual funds
Pros of ULIPs
- Combines life insurance and investment benefits.
- Provides tax benefits on premiums and maturity proceeds.
- Allows switching between different fund types.
Cons of ULIPs
- Higher charges reduce overall returns.
- Limited liquidity due to the lock-in period.
- Returns may be lower compared to pure investment options.
Pros of mutual funds
- No insurance-related costs, leading to higher net returns.
- Highly liquid with no lock-in period (except for ELSS funds).
- Diverse investment options based on risk appetite.
Cons of mutual funds
- No life insurance benefits.
- Returns are market-dependent and subject to volatility.
- Gains may be taxable depending on the holding period.
Conclusion
The choice between ULIP vs mutual fund depends on an investor’s financial objectives. ULIPs are suitable for those who want a combination of life insurance and investment, whereas mutual funds are better for those focusing purely on wealth creation.
For those requiring liquidity, mutual funds offer better flexibility, and loans against mutual funds provide an alternative to selling investments. Investors should evaluate their long-term financial goals, tax implications, and liquidity needs before deciding between ULIPs and mutual funds. By understanding these factors, they can make an informed decision that aligns with their financial future.