Ever since the taxability of long-term capital gains of equity funds was announced in Budget 2018, insurers argued that ULIPs may be a good option, given their tax-free status. With a slew of changes in Budget 2020 – a new category of tax slabs being introduced with very minimal deductions – is the narrative set to change? Industry experts and independent specialists weigh in.
Vighnesh Shahane, MD and CEO, IDBI Federal Life Insurance
Although this Budget dents the tax efficiency of life insurance policies slightly due to the choice to not avail of section 80C (under the new, optional regime) benefits, it in no way makes life insurance a less competitive product than mutual funds or any other investment avenue.
The initial reaction to the Budget announcement has been far more dramatic than what the final impact would possibly be. First, section 80C was a crowded bucket and the customer had a lot of choices other than life insurance. Second, we have been witnessing a reduction in the percentage of people buying life insurance purely for tax purposes. As awareness increases, more people are now buying life insurance for long-term savings and protection. Third, the maturity benefits under Section 10(10D), not applicable to mutual funds, would still be available.
It is incorrect to compare Ulips with mutual funds, as both satisfy different needs. Ulips offer a financial safety net to the insured – in case of her unfortunate death, the family will receive life insurance cover or prevailing fund value, whichever is higher. In the case of mutual funds, the nominees will only get the prevailing fund value, which could be even less than the originally invested amount in case of capital erosion due to market volatility.
Jimmy Patel, CEO, Quantum Mutual Fund
In the proposed new tax regime, both Ulips and equity-linked saving schemes (ELSS) stand to lose section 80C tax deductions. If one were to look at redemptions, however, mutual funds will attract long-term capital gains (LTCG) tax if the aggregate gains are over Rs 1 lakh. But, there is no dilution of tax benefits at maturity for Ulips. The Union Budget 2020 has abolished dividend distribution tax (DDT). Now, dividends will be taxable in the hands of investors. They will now have to compare their tax slab rate with the DDT rate to ascertain the additional tax outflow, if any. It will also increase the compliance burden. For example, senior citizens who invest in monthly income plans (MIPs) will have to keep track of the dividend they earn and file returns accordingly. DDT kept such hassles at bay all these years. So, the current status is not investor-friendly.
However, mutual funds score over Ulips in terms of expense ratios. If you compare online Ulips with direct mutual fund plans, the latter are cheaper. Better cost structures ensure that more of your money is available for investment, which means potentially higher returns. If an individual is looking for a life cover, it makes sense to invest in mutual funds and then take a term insurance cover. This combination will still be cheaper than investing in Ulips.
Pankaj Mathpal, Financial planner and Founder, Optima Money Managers
Mutual funds offer greater transparency, liquidity and choices, while Ulips offer more tax benefits. While both ELSS funds and Ulips offer section 80C tax benefits, the maturity proceeds, too, are tax-free in the case of insurance policies.
Also, when you invest in mutual funds through the systematic investment plan (SIP) route, each instalment is considered as a fresh investment. The units purchased will qualify for short or long-term capital gains tax based on the date of their purchase. If you surrender a Ulip after five years from the date of issuance, the proceeds will be tax-exempt even if the last monthly instalment was paid just a month ago. Unlike mutual funds, switching between Ulip funds does not attract any tax.
Union Budget 2020 has made dividends taxable in the hands of the recipients. An individual in the highest tax bracket may have to pay tax as high as 42.74 per cent. Nevertheless, the investor always has the choice of investing in the growth option, where capital gain tax applicable will be much lower, depending on the holding period and asset class.
Despite the tax disadvantage, I would still recommend mutual funds over insurance plans, as the former are less expensive and offer greater flexibility. You can switch to a better performing fund in case one doesn’t meet your expectation, which is not the case with a life insurance policy. At best, you are allowed to switch within the fund options available in that particular Ulip.
Archit Gupta, Founder and CEO, ClearTaxUnion Budget
2020 has proposed that dividends from equity mutual funds would now be taxable in the hands of the investor, reducing their overall income from this investment. A Ulip, being an insurance product, enjoys a tax arbitrage over mutual funds, though both may have invested their own corpus nearly similarly.However, Ulips cannot be considered superior to mutual funds purely on the basis of taxation. Equity mutual funds tend to deliver higher returns over a longer term than ULIPS. An investor can protect the tax rate dividends are subjected to, by opting for growth option. Equity mutual funds are also superior since they provide better liquidity, no lock-in periods and investors can exit when they want to. However, in a Ulip, an investor must necessarily remain locked-in for a period of five years. Exiting from one scheme and moving to another amounts to full redemption and the next lock-in will begin if an investor moves to another Ulip. An investor can easily redeem and move to another mutual fund without restrictions. Therefore, equity mutual funds continue to be more attractive. Those that opted for the dividend option of mutual funds will now need to evaluate the impact on their taxes. They would be better off going for the growth option.