ULIP vs Mutual Fund

Table of Content

1. What Is a Mutual Fund?

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

3. Differences between ULIP and Mutual Fund

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

5 ULIP and Mutual Fund: Which One to Choose?

6. Summing Up

7. FAQ's on ULIPs 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 Mutual Fund?

A mutual fund is an investment vehicle that collects money from a pool of investors to invest in diversified, market-linked assets. Qualified Asset Management Companies (AMCs) professionally manage such funds, making suitable investment decisions on behalf of the investors.

Fund managers generate returns based on the performance of the fund’s underlying assets, after deducting a small annual expense ratio to cover management and operational costs.

Here are the different types of mutual funds:

• Equity Funds: For long-term high-growth potential.

• Debt Funds: For fixed returns with low risk.

• Hybrid Funds: Provides a mix of equity and debt funds.

Mutual funds suit all kinds of investors. Small investors can begin with SIPs (Systematic Investment Plans) to invest systematically, or choose lump sum investments depending on their financial goals.

Benefits of Mutual Funds

• Flexible Withdrawal Options: All mutual funds allow fund withdrawals at any time, except for ELSS, which gives ready access to the money.

• Potential for Higher Long-Term Returns: As mutual funds invest the entire sum without reserving money for insurance cover, they can provide superior long-term returns.

• Higher Liquidity: Mutual funds offer products for various investment horizons, making them ideal for short- and medium-term financial planning.

Let us say you invest ₹5,000 per month in an equity mutual fund through a SIP. Your money is pooled with funds from other investors and managed by a professional fund manager, who invests in a diversified portfolio of stocks.

Over time, as the value of those stocks grows, your investment also appreciates. After a few years, depending on market performance and fund expenses, your ₹5,000 monthly contribution could grow significantly, all without you picking individual stocks yourself.

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

A ULIP is an insurance product that has life insurance protection combined with market-linked investments. It provides the double advantage of protection and wealth generation under one plan.

In a ULIP, partial premium is utilised for life insurance coverage, and the balance is invested in market-linked funds like equity, debt, or balanced funds. Investors can select funds as per their risk tolerance and financial objectives.

The majority of ULIPs permit investors to switch between funds during the policy period, providing flexibility to respond to market conditions.

In the event of a policyholder’s premature death, ULIPs pay out a death benefit to the beneficiaries who have been nominated. Premiums paid are eligible for tax deduction under Section 80C of the Income Tax Act 1961¹, while maturity or death benefits can be exempted from tax under Section 10(10D).

Benefits of ULIPs

• Combined Insurance and Investment: ULIPs provide life insurance coverage and investment in market-linked funds, suitable for goal-based financial planning.

• Tax Benefits Under Section 80C: The premium paid can be exempted from tax up to ₹1.5 lakh under Section 80C¹. Maturity and death benefits are also exempt from tax under Section 10(10D) ¹.

• Option to Switch Between Funds: Investors have the option to switch, helping them adjust their risks as per market movements.

Differences between ULIP and Mutual Fund

The following table shows a clear difference between mutual fund and ULIP plans:

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

ULIPs provide tax deduction benefits as per Section 80C of the Income Tax Act 1961¹ on premiums paid, up to ₹1.5 lakh a year, lowering taxable income. Moreover, death benefits received under ULIPs are completely 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.

ULIP and Mutual Fund: Which One to Choose?

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

ULIPs are best suited for those who want life insurance protection along with long-term wealth accumulation in a single, systematic investment scheme. As long as you can remain invested for 5 years or more and do not need liquidity too often, ULIPs offer a systematic method that matches well with financial goals such as retirement, child education, or inheritance planning.

These schemes provide tax advantages under Section 80C and Section 10(10D)¹ and receive structured, policy-driven benefits. ULIPs are appropriate for investors who like low-to-moderate risk, appreciate semi-automated fund management, and desire wealth creation along with family protection.

Who Should Choose Mutual Funds

Mutual funds are more appropriate for individuals who value investment return and flexibility over bundled advantages such as insurance. If you would like control over how and where your money is invested, want faster liquidity, or have short- to medium-term objectives, mutual funds give you more choice. They are available in the form of low-risk liquid funds to high-risk equity or sector funds, and allow easy switching or redemption.

Mutual funds are best for active investors who feel at ease with handling portfolio performance, managing capital gains taxation, and reacting to market movements. With relatively lower fees and openness in reporting, they are best for DIY investors or those assisted by financial advisors.

Summing Up

ULIP and mutual funds have different uses and must match your individual needs. ULIPs are the best option for individuals who desire a mix of long-term investment, life cover, and tax advantages. On the other hand, mutual funds are apt for investors interested in just wealth generation, high liquidity, and variable investment periods. The best choice depends on your risk appetite, time horizon, and financial priorities. Therefore, evaluate these carefully before making an investment decision.

FAQ's on ULIPs and Mutual Funds

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.