The Finance Minister’s rather unwelcome move to slap a long-term capital gains tax of 10 per cent on profits from the sale of equity mutual funds has brought unit linked insurance plans(ULIPs) into the spotlight as possible alternatives.

Proceeds from ULIPs enjoy a tax-free status at the time of redemption upon maturity.

But should you rush in to buy ULIPs and exit mutual funds based on tax difference alone? That would be a gross overreaction, as despite the 10 per cent tax on long-term gains, mutual funds still remain dependable bets for future goals.

Over the last ten years, many ULIPs have delivered stellar returns that are close to or, in select cases, even better that those of diversified equity mutual funds. Although charges are still pretty stiff vis-à-vis mutual funds, they have come down over the years.

While a major part of your portfolio should go to mutual funds, a small portion can be set aside for ULIPs or insurance pension plans after thoroughly checking their track record and charges.

Costs and returns

Mutual funds are pure investment products, whereas ULIPs combine investment and insurance. Hence, there are additional charges for ULIPs for mortality, premium allocation and fund management.

Typically, equity mutual funds charge 1.8-2.5 per cent as charges for their schemes. If you opt for direct plans, the charges come down by a further 50-75 bps, that is, to around 1.5 per cent annually.

Over a 10-year period, the best of equity schemes have delivered 16-18 per cent annually. If the last five years are considered, the returns are even better at 28-30 per cent for top-quality equity funds. And these are returns generated after all charges. But these gains would be taxed from April 2018, if they exceed ₹1 lakh. Dividends would be taxed too.

A typical ULIP charges 6-7 per cent for the first five years. They come down over subsequent years.

The insurance regulator IRDA specifies a maximum reduction in yield. So, the difference between gross and net (after deduction of charges) yields can be 4 percentage points in year five, 3 percentage points in year 10 and 2.25 percentage points after the 15th year.

The best of ULIPs have delivered 15-18 per cent returns over the last 10 years and 22-25 per cent over a five-year period. But if the charges are applied, the sheen of the returns wears off a bit.

Structure and lock in

Given their simple structure, low costs and strong returns over the long term, equity funds must definitely form the core of your portfolio. Except for tax saving funds, there is no rigid holding period for equity schemes.

But ULIPs have a minimum lock in of five years. Exiting earlier is prohibitively expensive.

Thus, they start paying off over the very long term of 10-15 years and, therefore, are suitable for patient investors with a reasonable risk appetite.

ULIPs allow you to spread investments across debt and equity. You are allowed to choose an investment pattern based on your risk appetite.

Right now, ULIPs proceeds are tax free.

Thus, for those of you with a long horizon of at least 10-15 years and reasonable risk appetite, it would be advisable to invest about 20 per cent of your equity portfolio in ULIPs.

Given that both debt and equity ULIPs are tax-free, there is added incentive for even conservative investors to take exposure for distant goals.

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