Has LTCG tipped the scales in favour of ULIPs vis-a-vis ELSS?

The imposition of the long-term capital gains (LTCG) tax in the Union budget 2018-19 spooked the stock market participants so much that the Sensex lost more than 600 points immediately after the announcement on February 1.  Thereafter, the Sensex has continued on its downward march, the market sentiments being further exacerbated by the global meltdown on February 5-6. 

In his budget speech, Finance Minister Arun Jaitley had said, "I propose to tax such long-term capital gains exceeding Rs 1 lakh at the rate of 10% without allowing the benefit of any indexation." The imposition of 10 per cent tax on LTCG exceeding Rs 1 lakh made from the sale of stock and equity mutual fund units held for over one year implies that the benefit of holding the stocks and mutual fund units for a year or more will not be available from April 1, 2018, onwards. This imposes an additional tax burden on those looking to earn income from their investments in the stock market. Moreover, since the indexation benefits will not be available on the LTCG, the returns would be further eroded due to the impact of inflation.

However, it must be noted that unit-linked insurance plans (ULIPs) have been exempted from the LTCG tax, which makes them an attractive proposition now. ULIPs are equity-linked insurance products that aim to provide equity-oriented growth on investment along with insurance cover. The exemption of ULIP from the 10% LTCG tax now makes it all the more attractive than other equity-oriented mutual fund schemes such as ELSS. That apart, the benefit of E-E-E (Exempt-Exempt-Exempt) tax structure available for ULIP makes it a hugely tax efficient product, as compared to pure equity funds.

However, it must be noted that while ULIP has a lock-in period of 5 years, while ELSS has a lock-in period of 3 years. Also, ULIPs are less liquid than ELSS and the expense ratio in the case of ULIP may be higher (on account of various charges) than ELSS as the expense ratio in the case of the latter is tightly regulated. A higher expense ratio can diminish the returns of ULIPs as compared to ELSS.

In view of the above, it would be a good idea to invest in ULIP as well as ELSS to benefit from the advantages of both the products. The proportion of allocation of funds between these schemes should depend on the risk appetite, return expectations and investment horizon of the investor.