ELSS vs ULIP: Choosing the Best Investment Option for You

A diversified equity strategy with a three-year lock-in period is known as an equity-linked savings system or ELSS, provided by mutual funds in India. A ULIP investment, on the other hand, is an insurance policy that allows you to invest money to achieve your long-term objectives. Now let’s find out which option is the best for you. 

To understand what ULIP is, you need to get into the inner dynamics of the same. At the same time, the confusion amongst investors regarding ULIPs or ELSS has been prevalent for quite some time. Although they differ from one another and serve various financial purposes, “unit-linked investment plans” (ULIPs) and “equity-linked savings schemes” (ELSS) are similar to each other in some ways as well. Therefore, matching your long-term financial objectives to ULIPs and ELSS is essential before deciding. Here we’ll make this ULIP vs ELSS conundrum simpler for you. 

Which Investment Option Should You Consider: ULIP or ELSS

Here are some key pointers worth considering in this regard: 

  1. Product Feature And Type: The key distinction between the two product types and fundamental characteristics is that ELSS is only a mutual fund, in contrast to ULIPs. A ULIP is broader since it combines insurance with investing, with most of the investment going into mutual funds. A crucial point of distinction is that insurance firms primarily offer ULIPs. The insurance provider pays the investor’s nominee the greater of the insured amount or the mutual fund value units in the ULIP as the death benefit for Type-1 ULIPs. For Type-2 ULIPs, the sum assured is paid to the nominees. ELSS will provide the whole of the fund’s value as of the redemption date.
  2. Investment Objectives: ELSS, like most equity funds, focuses solely on corpus creation, although it has a 3-year lock-in term. Experts advise keeping the units for at least 5 to 7 years for better returns. The goal of a ULIP is to give an insured person life insurance that also offers the possibility of capital growth. Due to the fact that ULIPs mix insurance and investment, they differ from standard insurance products.
  3. Risks: ELSS is unquestionably a high-risk investment because it is a mutual fund scheme that distributes 65 to 80 per cent of its assets to stocks. Since the policy coverage is assured regardless of investment returns, ULIPs are less hazardous than ELSS. The ULIP may also contain debt, equity or even hybrid fund units, which balance their risk levels. Investors can switch funds across several types periodically to maximize returns or minimize risks. 
  4. Returns: It is worth stating once more that, in contrast to a ULIP investment, ELSS invests 100% of the funds investors purchase for fund units. Hence, it seems that ELSS has a chance to offer greater returns than ULIPs in some cases. Also, if there is more investment of ULIPs in debt instruments, the returns will be steadier but on the lower end of the spectrum compared to equity funds.
  5. Tax Computation: Under Section 80C, ELSS and ULIP are both tax-deductible up to Rs. 1.5 lakh each financial year. However, following the respective 3-year and 5-year lock-in periods, they are taxed when the ELSS and ULIP units are redeemed. ULIPs are taxed in accordance with the new government standards under 8AD as of February 1, 2021, while ELSS is taxed similarly to equity funds.
  6. Liquidity: ELSS provides more liquidity because it has a shorter lock-in time than ULIPs. Because ELSS has the shortest lock-in period of only 3 years among all Section 80C tax saving techniques, it is frequently the most popular option among investors. The lock-in term of the ULIP is 5 years, with no option for premature withdrawal available in either ULIP or ELSS. Since the lock-in period is shorter, ELSS provides more liquidity than ULIP.
  7. Switching Option: The ability to swap between asset classes is a primary characteristic that distinguishes the ULIP from the other investment options. The investors in ELSS cannot choose some other fund or alternative investment allocation because ELSS is, inescapably, an equity fund. In contrast, ULIPs are insurance products allowing investors to select the funds they want to invest in. They may even decide to change to a different type of fund in the future. This has two advantages: first, investors can swap funds, and second, they can invest in a variety of funds, depending on their changing goals and market movements.
  8. Expense Ratio: The expense ratio, calculated as a percentage, is a highly significant factor in mutual fund investments. These fees are imposed by fund houses to cover the cost of running and managing the fund. A greater expense ratio entails paying a larger portion of the returns as a charge for the fund’s expert management. This eventually impacts the returns that investors receive. This varies across fund houses and insurance firms for ELSS and ULIPs. 

In a nutshell, both ULIP and ELSS qualify as Section 80C tax-saving financial vehicles, despite having entirely different product types. Additionally, they are governed by several IRDA (Insurance Regulatory and Development Authority) and SEBI (Securities and Exchange Board of India) regulatory mechanisms. Since ULIPs are insurance products with investment features, IRDA supervises them, while SEBI controls ELSS, which is entirely a mutual fund. As a result, different tax laws, risk-return portfolios, and lock-in periods apply to ELSS and ULIP. However, it is worth mentioning that ULIPs enable long-term wealth creation while simultaneously ensuring much-needed allocation flexibility and insurance coverage. They are a complete investment option as a result.