Single premium, unit-linked insurance plans (SP Ulips) from life insurers have been the preferred flavour for a lot of people who ‘invest through insurance’. Their main draw is the tax break under Section 80C of the Income tax Act, 1961. For many, they have filled the void left by the Life Insurance Corporation’s popular fixed-return, single-premium plan, Bima Nivesh.
However, there have been quite a few additions to the universe of financial instruments in recent times, and equity-linked savings schemes (ELSS) are one of them. They, too, give tax breaks and allow lump sum investment. So how do they stack up against SP Ulips?
The Ulip option. A Ulip packages a life cover with investment in units similar to mutual funds (MFs). So, while part of your premium pays the administration charge, the rest is invested in assets like equities or debt, depending on your choice.
Going by the way you pay your premiums, Ulips can be of two types. The first is the regular premium paying option, where you pay a fixed amount every year (monthly, quarterly, half-yearly or annually) for at least the first three years of the policy. The second is the SP Ulip, where you have to pay a lump sum just once.
If you choose the regular premium option, in the first three years, the cost you have to bear is about 60 per cent of the premium you pay. Alternatively, if you buy SP Ulips for three consecutive years, it would cost you around 10 per cent of the premium you pay every year. So, the SP Ulip is the obvious choice among the two.
The ELSS option. An ELSS is a diversified equity mutual fund scheme. You can make a one-time investment.
The similarities. For both SP Ulips and ELSS, you have to invest once and the investment is locked in for three years. Under the present tax laws, what you get on maturity is tax-free. While in ELSS your entire investment will be in equity, SP Ulips give you the choice of investing in equity or debt instruments, or both, and the choice to move from one to the other.
The differences. The biggest difference is that SP Ulips give you a life cover, while ELSS does not. So the ‘mortality cost’ of insuring your life is deducted from the value of the fund every month. When the plan matures, the value of the units, or fund value, is yours. If a policyholder dies during the plan term, the higher of sum assured or fund value is paid to the beneficiary. However, some plans like Met Smart Premier of MetLife Insurance and Bajaj Allianz UnitGain Guarantee SP pay out both, albeit at a higher cost.
The tax laws. According to the Insurance Regulatory and Development Authority (Irda), the life cover of a SP Ulip has to be at least 125 per cent of the premium. But under I-T rules, if the premium paid for a policy is more than 20 per cent of the sum assured in a year, then deduction from taxable income will be allowed only up to 20 per cent of the sum assured. In other words, to get the entire premium deducted from taxable income under Section 80C, make sure the cover is at least five times the premium.
The costs. In an ELSS, the amount invested is subjected to only two charges. One is the entry cost or the load, which is normally 2.25 per cent of the amount invested. After the units are allotted, there are recurring charges also called the expense ratio. For ELSS, the average is around 2.25 per cent of the fund value, while the maximum permitted is 2.5 per cent.
For SP Ulips, first there is the premium allocation charge. Akin to the entry load for an ELSS, it ranges from 2 to 4.5 per cent for amounts below Rs 1 lakh, and goes down for higher amounts. Then there is fund management cost, which is similar to the MF recurring expense ratio.
Further, there is the mortality cost, which is based on the difference between the sum assured and the value of the fund. Some SP Ulips also carry a ‘surrender charge’ for exiting the plan in the fourth and fifth years as well. Then there is the ‘policy administration charge’. It is deducted from the fund value either as a percentage, a fixed sum every month, often based on the sum assured.
Irrespective of how the charges come in, the post-charges returns from most SP Ulips is below that from the ELSS funds for lower amounts. Lower front-end costs often come with higher mortality rates and policy administration charges, and so on.
The returns. Since both SP Ulips and ELSS have a three-year lock in, to compare them, one should look at their three-year returns. However, since many of the SP Ulips have been operating for less than three years, we have considered their last one-year performance.
Of the 29 open-ended ELSS plans in the market today, the average return as on 16 April 2007 has been 3.90 per cent over the last one-year. Funds like Can Equity Tax Saver and Prudential ICICI Tax Plan have delivered negative returns of 21.89 per cent and 8.64 per cent, respectively, against the Sensex return of 18.74 per cent during the same period. While none has managed to beat the benchmark Sensex, six funds have managed double-digit returns with Fidelity Tax Advantage delivering highest return of 18.03 per cent.
The 10 SP Ulip plans in operation for the last year have given average returns of 12.2 per cent. While none of them have given a negative return, individual returns are between 6.55 per cent and 15.01 per cent. Over five years, the benchmark Sensex has given returns of 32.01 per cent and out of 17 ELSS funds in existence since five years, only four have underperformed the Sensex. The SBI Magnum Tax Gain Scheme 93 has delivered a compounded annualised return of 55.10 per cent. Meanwhile, ICICI Prudential’s Life Link, a SP Ulip, an early entrant, has just managed to beat the benchmark by delivering compounded annualised return of 32.92 per cent over the same five-year period.
The decision. Given the cost structures and the return rates over the last few years, ELSS emerges as the better option if you are looking purely at saving taxes through investment. (In fact, if you need insurance you can buy a pure term life cover, which is usually quite cheap.)
Costs in the MF industry are standardised, but not in insurance. So, for SP Ulips, there are more charges and different companies factor them in differently. So it is tougher to compare the nature of their impact on the investible part of your premium. Eventually, the price of a SP Ulip works out higher than ELSS.
But then, all ELSS schemes do not perform equally well. So you will have to choose based on factors like risk-adjusted returns. (See: Best Funds 2007, 30 April).
An SP Ulip may make sense in the longer term, as the costs are front-loaded. It may make sense for larger amounts, too, since there would be no entry costs in most cases.
But purely to save taxes, that, by implication, limits investments to Rs 1 lakh, ELSS will be the way to go till SP Ulips standardise and reduce their costs.
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