ULIP vs Mutual Funds

Table of Content

1. What is a Unit-Linked Insurance Plan (ULIP)?

2. What Is a Mutual Fund?

3. Difference Between ULIP and Mutual Fund

4. Benefits of ULIP and Mutual Funds

5. Factors to Consider Before You Decide Between ULIP and Mutual Fund

6. Which to Choose? - ULIP vs Mutual Fund 

7. Conclusion

8. FAQs on ULIP and Mutual Funds

As investors strategise their long-term financial planning for 2025, understanding the difference between ULIP and mutual funds is crucial. These are preferable long-term investment options but serve different purposes.

Mutual funds are investment-oriented products that enable you to invest in equity, debt, or hybrid funds. They have high fund flexibility and liquidity with no lock-in period except for 3 years in the Equity Linked Savings Scheme (ELSS).

On the contrary, ULIPs merge life insurance and investing. Insurers allocate a part of the premium to life cover and invest the remaining in market-linked funds. However, they enforce a compulsory 5-year lock-in and restrict fund options to their own products.

In mutual funds, there is greater flexibility, whereas in ULIPs, the investment risk falls on the policyholder. However, selecting the best option depends on your need for insurance, flexibility, risk appetite, and goal horizon.

What is a Unit-Linked Insurance Plan (ULIP)?

A ULIP is a hybrid financial product that combines life insurance protection and investment growth in one plan. To understand the ulip meaning, when you pay a premium, one part provides life cover, and the other part is invested in funds such as equity, debt, or balanced options.

You can select a fund based on your risk level and long-term goals. ULIPs also offer flexibility to switch between funds during the policy term, helping you respond to changing market conditions. 

If the policyholder passes away, the death benefit is paid to the designated beneficiary or nominee. ULIPs also offer tax benefits, including deductions under Section 80C of Income Tax Act, 1961 and tax-free payouts under Section 10(10D) subjected to conditions specified, making them a valuable tool for long-term financial planning.

Example of a ULIP:

For instance, if you buy a ULIP with an annual premium of ₹50,000, approximately ₹5,000–₹7,000 may go toward life cover and charges. On the contrary, the remaining amount is invested in your chosen fund, such as an equity fund for higher long-term returns. 

Over the years, you can choose between ULIPs and mutual funds if markets become volatile. This way, if something happens to you, your nominee receives the assured life cover or the fund value, whichever is higher.

What Is a Mutual Fund?

Mutual funds are investment vehicles that pool money from many investors and invest it in a diversified mix of market-linked assets such as equities, bonds, or a combination of both. 

They are managed by Asset Management Companies (AMCs), where professional fund managers make investment decisions on behalf of investors. This makes mutual funds ideal for individuals who lack the time or expertise to pick individual securities. 

Key types include Equity Funds for growth, Debt Funds for stability, and Hybrid Funds for balanced risk. Investors can invest through Systematic Investment Plans (SIPs) or make lump sum contributions.

Difference Between ULIP and Mutual Fund

The following table shows the difference between ULIPs and mutual funds:

Benefits of ULIP and Mutual Funds

• Primary Objective

Choose a ULIP if you want life insurance plus long-term investment growth in one plan. Choose a mutual fund if your goal is pure wealth creation without the need for insurance. Understanding this core objective helps match your investment to your financial needs.

• Tax Benefits¹

ULIPs offer tax deductions under Section 80C¹ of the Income Tax Act, 1961 and tax-free maturity payouts under Section 10(10D)1 subject to conditions specified and death benefits are completely exempt Mutual funds offer Section 80C benefits only in case of ELSS Schemes, while other mutual funds are subject to LTCG or STCG taxes based on holding period.

• Portfolio Flexibility

ULIPs offer equity, debt, and balanced fund options, but switching is limited and tied to policy rules. Mutual funds provide a wider range of schemes and allow easier, flexible switching, making them ideal for active, market-aware investors seeking greater flexibility.

• Financial Goals & Investment Horizon

ULIPs suit long-term, goal-based planning because they feature a 5-year lock-in period and a structured investment approach. Mutual funds cater to a range of short, medium, and long-term goals, offering greater liquidity and easy withdrawals to accommodate changing financial needs over time. 

• Risk Factor

ULIP risk varies by chosen fund type and is partly cushioned by the insurance component. Mutual fund risk depends entirely on the scheme, ranging from low-risk debt to high-risk equity, affecting return potential and investor suitability. 

• Liquidity / Need for Money

ULIPs have a mandatory five-year lock-in, making withdrawals or surrenders before this period restricted and often subject to penalties. This limits immediate access to funds. Mutual funds offer significantly higher liquidity, allowing investors to redeem units quickly, often within 1 to 2 working days, making them suitable for short-term or emergency financial needs.

Factors to Consider Before You Decide Between ULIP and Mutual Fund

Choosing between ULIP and mutual fund will require the consideration of certain factors, which are given below:

Tax Benefits

ULIP taxation offers multiple advantages under the Income Tax Act, 1961. Premiums paid towards ULIPs are eligible for tax deductions under Section 80C, up to ₹1.5 lakh per year, helping reduce taxable income. Additionally, the death benefit received under a ULIP is fully tax-free.

Maturity benefits are tax-free under Section 10(10D)¹, subject to an annual premium not exceeding ₹2.5 lakh. In case the annual premium exceeds this amount, long-term capital gains (LTCG) over ₹1.25 lakh are taxed at 12.5%.

Equity-Linked Savings Schemes (ELSS) alone are eligible for tax deduction under Section 80C, up to ₹1.5 lakh per year. There are no tax deductibles for other mutual fund schemes such as debt, hybrid, or equity funds.

The government imposes a 10% LTCG tax on equity fund profits exceeding ₹1 lakh if held for over a year, and a 15% STCG tax on withdrawals made within a year.

Portfolio Flexibility

ULIPs offer a choice of investing in equity, debt, or balanced funds based on the investor’s risk appetite and financial objectives. They allow fund switching, typically with a finite number of free switches within a policy year, to enable investors to react to market changes.

However, the fund choice is limited to the fund options provided by the insurance company.

Mutual funds provide wider portfolio flexibility. Investors have access to a large variety of fund categories, including large-cap, mid-cap, debt, hybrid, and sectoral. This enables investors to switch between them by redeeming and reinvesting as desired, although this comes with exit loads and tax implications.

Moreover, this flexibility provides a quicker response to market changes, making mutual funds more suitable for active investors.

Financial Goals & Investment Horizon

ULIPs are best suited for long-term financial objectives like retirement planning, a child's higher education, or long-term wealth creation. They are subject to a mandatory 5-year lock-in period and induce long-term financial discipline.

Furthermore, premature surrender is likely to result in penalties or lower benefits. Hence, ULIPs are best suited for goal-oriented investors with low liquidity requirements.

Mutual funds serve a range of investment time horizons, short, medium, or long-term, with high flexibility. For short-term objectives, ultra-short-term debt funds or liquid funds are appropriate.

For long-term objectives, equity and hybrid funds are preferable as per the investor’s risk tolerance. There is no lock-in, except for ELSS (3 years) and close-ended schemes. This flexibility makes mutual funds a preferable choice among investors with changing financial objectives and time horizons.

Risk Factor

Market risk is greater in ULIPs based on the type of funds chosen. Equity ULIPs are riskier, and debt-based ULIPs provide more stability. These are attractive to risk-averse investors because of their embedded life insurance, long-term horizon, and fund switching option, which facilitates deliberate shifting.

ULIPs are generally preferred by investors with low to medium risk tolerance who seek gradual, secure, and steady wealth creation.

Mutual funds span a wide range of risks, including low-risk debt and liquid funds to high-risk small-cap, theme, and sector funds. Investors face full market fluctuation and need to track their investments continuously or depend on fund managers.

Moreover, mutual funds are better for moderate to high-risk appetite investors with knowledge of market cycles. They also allow adjusting risk levels in the long run through planned asset allocation.

Which to Choose? - ULIP vs Mutual Fund

ULIPs are ideal for investors looking for bundled insurance and long-term discipline. On the contrary, mutual funds are ideal for investors who are interested in flexible, high-growth investments with no insurance benefits.

Selecting ULIP plans and mutual funds according to your risk tolerance, goal duration, and tax requirements is crucial.

Who Should Choose ULIPs

Choose a ULIP if you want life insurance along with long-term disciplined investing. ULIPs suit individuals seeking protection plus wealth accumulation, structured savings, and tax benefits. They are ideal for long-term planners who prefer goal-based investing.

Who Should Choose Mutual Funds

Choose a mutual fund if you prioritise flexible, high-growth investments without insurance. Mutual funds are suitable for investors seeking liquidity, diverse investment options, and the ability to switch or redeem easily. They accommodate all risk levels (low to high) based on the selected scheme.

Conclusion

Choosing between ULIPs and mutual funds depends on whether you prefer insurance with long-term disciplined investing or a purely flexible, market-linked investment option. ULIPs are better suited for individuals seeking life insurance coverage, tax benefits, and structured goal-based savings. Mutual funds are suitable for investors who seek liquidity, diverse investment options, and the freedom to manage risk across different time horizons. Understanding your financial goals and risk comfort will help you make the right choice.

FAQs on ULIP and Mutual Funds

Q. Are ULIPs a good investment compared to mutual funds?

ULIPs are a good option if you want life insurance plus long-term investing in one plan, along with tax benefits and disciplined savings. However, mutual funds generally offer higher liquidity, lower costs, and greater flexibility. They may provide better returns since the entire investment goes toward market growth. The better choice depends on your goals and risk appetite.

Q. How do ULIP returns compare with SIP in mutual funds over 10 years?

ULIP returns over 10 years often remain moderate because insurers allocate part of your premium toward life insurance charges, reducing the amount invested. SIPs in mutual funds typically generate higher returns since they invest your entire contribution in market-linked funds. Mutual funds also benefit from rupee-cost averaging and lower costs. However, actual returns depend on fund performance, risk level, and market conditions.

Q. Which is better ULIP or mutual fund?

Whether ULIPs are better or mutual funds depends on what the investor is looking for. Investors looking for both investment and life cover options, seeking tax benefits, and preferring capital protection over returns can opt for ULIPs. On the other hand, investors prioritising cost efficiency and high liquidity can go for mutual funds.

Q.Is it good to invest in ULIP?

Yes. It is good to invest in ULIPs if you are looking for both life cover and investment components in a single plan. ULIPs help grow your money over time with the investment component and provide financial security for your family in your absence with the life coverage component.

Q.What are the tax benefits of ULIP?

The premiums paid towards ULIPs in a financial year are eligible for tax deduction under Section 80C of the Income Tax Act 1961¹, and the death benefit and maturity benefit is tax-exempt under Section 10(10D) subject to conditions as prescribed.

Q. When is the best time to make mutual fund investments?

There is no specific best time to make mutual fund investments. However, investing in a bearish market with potential for future growth is ideal, according to professionals in the investment field

Q. Which is a more flexible investment – ULIP or mutual fund?

Mutual funds are a more flexible investment option as they provide a wider range of investment options and more liquid as they do not have a lock-in period. ULIPs provide both life cover and investment components, but have lower flexibility in fund selection. They also have a lock-in period that restricts access to funds in times of need.

Q. What is the main difference between ULIP and mutual funds?

The primary difference lies in the structure: ULIPs combine life insurance with market-linked investments, offering both financial protection and returns. Mutual funds are investment-only schemes without any insurance cover. If you are looking for twin benefits, opt for ULIPs; if you desire focused investment choice, mutual funds are the way to go.

Q. What are the disadvantages of ULIP?

ULIPs have a 5-year lock-in duration, restricting premature withdrawal. They also have several charges, including mortality charges, fund management, and administration charges that decrease the overall returns. ULIPs could provide lower returns in comparison to mutual funds because of the insurance element and policy rule structuring.

Q. What is the difference between ULIP lock-in period and mutual fund liquidity?

ULIPs have a lock-in of 5 years, i.e., you cannot withdraw money during this time. On the other hand, mutual fund investors can redeem their units at any time, except in the case of ELSS (which has a 3-year lock-in) or closed-ended funds. Therefore, mutual funds are preferable for those having short-term financial needs.