It’s time for the Union’s budget, and time to discuss fiscal aspects, among others. Let’s discuss the difference in tax treatment between investments in mutual funds and ULIPs. Until the 2021 finance law, it was open sesame, from a tax point of view, in favor of ULIPs. There is a tax benefit under Section 80C and the proceeds at maturity are exempt from tax under Section 10(10D). There are conditions under Section 10(10D), that the sum assured in a life insurance policy is at least 10 times the annual premium and can be withdrawn after a lock-up period of 5 years . Nevertheless, you get the proceeds tax-free.

In the previous year’s Union budget, presented on February 1, 2021, a new regulation came that in ULIPs purchased since that day, if the premium is more than Rs 2.5 lakh per investor per fiscal year, the proceeds would be taxable. This regulation has reduced the disparity to some extent. In other words, for high-value ULIPs, the product is taxable in the same way as mutual funds.

However, it is not an even playing field. For premium ULIPs below Rs 2.5 lakh per fiscal year, the proceeds are tax free. From a practical point of view, what are ULIPs? These are investment products with insurance coverage. If the argument is that the tax benefit is an incentive to purchase insurance coverage, this can also be achieved through term insurance.

Mutual funds have certain advantages as investment vehicles over ULIPs. Flexibility is a big advantage. Whenever you want to exit, whether due to cash flow needs, allocation changes or performance issues, you can do so seamlessly in mutual funds. Some funds may have an exit charge for a period of time, but most funds do not have this clause, and beyond the exit charge period, there is no charge. On the fees charged, there is transparency: the fees are declared daily on the respective sites of the UCITS. The total expense ratio (TER) charged by mutual funds to a fund (technically called a plan) includes everything, e.g. out-of-pocket expenses, distribution commission for the regular plan, margin for the AMC, etc. As the AUM size of an MF diet increases, the TER gradually decreases. Transparency on portfolio disclosure and fund management strategy is also better in MFs.

However, from a fiscal point of view, the rules of the game are not level playing field. The Section 80C benefit is only available in one category of MFS funds, i.e. Equity Linked Savings Schemes (ELSS). Although some note sizes of ULIP investments have been made taxable, all traditional non-ULIP policies are non-taxable investment income. In a way, the system gives the message that the investor is encouraged to go through the ULIP route.

If the thought process of regulators is to incentivize and spread the concept of insurance coverage for the benefit of families, this can also be achieved through the MF route. A new rule may be introduced that for MF investments, up to a certain age bracket, the investor may purchase term insurance up to a certain coverage or premium amount in proportion to the MF investments. The requirement may be similar to that of Article 10(10D), whereby the margin must be at least 10 times the amount of the investment in the tax-exempt MF. As a package, i.e. MF investment plus term insurance cover, it may be eligible for tax exemption on maturity or withdrawal. A certain blocking of FCP investments which have been subject to tax exemption, for example 3 or 5 years, may be prescribed.

What would be the benefit of this move? The culture of savings and investments would be propagated, not only through the ULIP route, but also through the more widespread MF route. Insurance penetration among the insurable population would be encouraged, which would spread a desirable habit. Investors would benefit from better portfolio transparency, fund management policies and disclosure of MF expenses. Investors would also benefit from the flexibility; Although we have discussed the lock-in argument for MF investments set up for tax exemption, it is likely that the lock-in period would be less than the usual duration of ULIP products.

The spread of the FM industry requires system support, not only in the form of strong regulation by SEBI, but also other incentives. The Sumit Bose committee had pointed out that there was a disproportionate incentive structure in the life insurance industry. Therefore, from the point of view of the whole investor population, this decision deserves to be taken into account in the next Union budget.

(The author is a corporate trainer and author.)