Debt ULIPs Vs Debt Mutual Funds: Which is a Better Option?

Currently, the debt funds are witnessing a strong market fluctuation, specifically after RBI cutting rates. While many investors are taking advantage of the market movement by investing in bonds, debt mutual funds, there is one more category offered by i.e. ULIP debt-oriented funds. Unit Liked Insurance Plans (ULIPs) offered by life insurance companies provide an opportunity to invest in equity and debt funds.

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The returns generated entirely depend on the market performance of the fund. The individuals, who want to analyze, which is a better option for investment should consider the following factors before making an informed choice. 

Expenses 

Compared to the equity investment, the debt fund offers thin margins. Thus, it is important to choose low- cost debt investment. If two debt funds have equal returns, then the one with the lower cost should be preferred. Debt mutual funds are comparatively more cost-effective. The expense ratio of debt mutual funds is capped at 2.25% by the regulator, which can exceed up to 3% if the fund is sold in the Tier II or Tier III cities. 

Although, earlier ULIP has a higher expense ratio, the revised expenses of ULIP plans proposed by the IRDAI (Insurance Regulatory and Development Authority of India) have made it more competitive. Now for a 10-year ULIP plan, the insurance company can charge up to a maximum of 3% and 2.5% for 15 years ULIP plan. 

In debt funds, there is no entry load applicable and exit load is applicable only in case of premature redemption. Moreover, with ULIP plans, the agents' commission is also applicable, which can be quite high. 

Insurance 

As mutual funds are pure investment product, they do not have any life insurance element. However, ULIP plans are insurance cum investment product, thus they offer the combined benefit of investment returns and insurance coverage. ULIP can be considered as a lucrative option of investment for investors who prefer to keep their insurance and investment portfolios the same. 

Tax Benefit

Debt mutual funds do not offer any tax benefit. The short-term gain on debt mutual funds is added to the income and is taxed as per the applicable tax slab rate. Moreover, the long-term gains are taxed at a lower of 10% without indexation benefit and 20% with indexation benefit. On contrary to this, ULIP offers the benefit of tax exemption at all three stages in form of EEE (exempt, exempt, exempt) format. This means that the investment made towards the ULIP debt funds, the interest gained on it and the maturity proceeds are tax exemption as per the applicable tax law. 

*In Budget 2021, to rationalize ULIP taxation, it is proposed to allow tax exemption in ULIP for maturity proceeds having an annual premium up to Rs.2.5 lakh. However, the amount received as death benefit shall continue to remain tax exempted without any applicable limits on the premium amount. The limit of Rs.2.5 lakh on annual premium of ULIP shall be applicable only for plans taken on or after 01.02.2021.

Lock-in Period

Debt mutual funds do not have any lock-in period. The exit load is applicable only in case of premature withdrawal of funds. However, ULIP plans come with a lock-in period of 5 years from the date of policy initiation. While the lock-in period helps to inculcate the habit of disciplined investment among investors, it is more useful in equity-linked investment. 

Debt Funds 

Debt Funds are market-linked securities in which, the money is invested with an objective to provide regular and secure return. In a debt fund, the investments are made in fixed income securities like treasury bills, corporate bonds, government securities and other money market instruments. Considered to be a low-risk investment option as compared to the equity investment, the debt funds are preferred by investors who have a low-risk appetite. 

To help the readers know more about debt funds, here we have explained in detail the different aspects of it. 

What are Debt Funds?

Debt funds mainly invest in fixed income securities like corporate bonds, treasury bills, etc. The objective of these funds is to create wealth in the long-term along with the benefit of steady and regular returns. These funds come with a pre-decided date of maturity and interest rate that the investors can earn on maturity, thus it is known as fixed-income securities. The returns are generally not affected by market fluctuations. Hence, debt funds are considered a low-risk investment option. 

How Does Debt Fund Work?

Every debt fund has a credit rating based on which, the fund manager invests majorly in the underlying assets. A higher credit rating of debt securities indicates that it has a higher chance of paying interest regularly along with the repayment of principal amount on completion of the investment tenure. Based on different factors, fund managers choose these securities. The fund managers can choose to invest in short-term or long-term debt securities based on whether the interest rate applicable to the securities are rising or falling. Sometimes investing in low-quality debt securities provides an opportunity to earn higher returns. However, investing in high-quality debt security will provide more stability. 

List of Top Performing ULIP Debt Funds to Invest in India 2021

Here is the list of top-performing ULIP debt funds to invest in India 2021. 

ULIP Scheme

Category

Returns

 

 

1 year

3 years

5 years

Aditya Birla Sun Life Classic Life Premier Builder Plan

Other

15.20%

9.30%

9.50%

Aditya Birla Sun Life Prime Life Premier Builder Plan

Other

15.20%

9.30%

9.50%

Aditya Birla Sun Life Classic Life Premier Enhancer Plan

Other

22.40%

8.90%

9.30%

Bajaj Allianz- New Family Gain Bond Fund Plan

Debt long-term funds

5.30%

7.60%

7.60%

Bajaj Allianz- New UnitGain Super Bond Fund Plan

Debt long-term funds

5.30%

7.60%

7.60%

Bajaj Allainz UnitGain Debt Plan

Debt Long-term funds

3.30%

5.40%

5.30%

Bajaj Allainz- UnitGain Plus Cash Plus

Debt Short-term funds

3.70%

5.30%

5.80%

Exide Life- One Life- Growth Plan

Large -cap Oriented Fund

36.40%

10.20%

10.90%

Exide Life- Future Perfect- Growth Plan

Large-cap oriented fund

36.40%

10.20%

10.90%

Exide Life- Freedom plan- Secure Plan

Other

15.20%

10.00%

9.20%

HDFC Standard- Unit Linked Young Star Plus Balanced Managed Fund

Other

34.20%

10.50%

11.50%

HDFC Standard- Unit Linked Endowment Balanced Managed Fund

Other

34.20%

10.50%

11.50%

HDFC Standard-Unit Linked Pension Balance Managed Fund

Other

34.20%

10.20%

11.60%

Kotak Easy Growth- Dynamic Bond

Debt Long-term Funds

6.90%

9.60%

8.50%

Kotak Retirement Income Plan Pension Bond

Debt Long-term Funds

6.70%

9.50%

8.50%

Kotak Easy Growth Plan- Dynamic Balanced

Other

31.60%

9.40%

10.50%

Kotak Easy Growth Plan- Dynamic Floating Rate

Other

4.00%

6.00%

6.10%

Kotak Flexi Plan Guaranteed Balanced

Other

7.60%

3.10%

6.30%

PNB MetLife- Met Smart Premier Preserver

Other

5.10%

7.70%

7.10%

Disclaimer: *Policybazaar does not endorse, rate or recommend any particular insurer or insurance product offered by an insurer.

The investment risk in investment portfolio is borne by the policyholder

*All savings are provided by the insurer as per the IRDAI approved insurance plan. Standard T&C Apply

Types of Debt Funds

Based on the maturity period, debt funds are classified as follows: 

Liquid Fund 

Under this fund option, the investment is made in money market instruments, which come with a maximum maturity period of 91 days. Liquid funds tend to offer better returns as compared to the savings account and are good short-term investment alternatives. 

Money Market Fund

Under this fund, the investment is made in a money market instrument, which comes with a maximum maturity of 1 year. These funds are best suitable for investors who want to invest in low-risk debt securities for the short-term. 

Dynamic Bind Fund 

In this fund, the investment is made in debt instruments with different maturity date based on the interest rate regime. These funds are best suitable for investors who have a moderate risk appetite and who want to invest for a tenure of 3-5 years.

Corporate Bind Fund 

Under this fund, a minimum of 80% of the total assets is invested in corporate bonds having the highest interest rate. These funds are best suitable for investors who have a low-risk appetite and who want to invest in a high-quality corporate bond. 

Gilt Fund

In this fund, a minimum of 80% of the investment is made in government securities, which come with different maturity tenures. The gilt fund does not carry any credit risk. However, the risk associated with the interest amount is high. 

Banking and PSU Fund 

In this fund, a minimum of 80% of the total asset is invested in debt securities of PSUs (Public Sector Undertakings) and Banks. 

Credit Risk Fund 

In this fund, a minimum of 65% of the total asset is invested in corporate bonds having a lower rating as compared to the highest quality corporate bonds. Thus, these funds offer a better return as compared to the high-quality bonds and carry a certain amount of credit risk. 

Overnight Fund 

As the name suggests, these funds have a maturity period of 1 day, which are considered very safe as both interest risk and credit risk are negligible. 

Floater Fund 

Under this fund, a minimum of 65% of the total amount is invested in floating rate instruments. The risk associated with the applicable interest is low. 

Low Duration Fund 

In this fund, the investments are made in a combination of debt and money market securities in a manner that the maturity period of the scheme ranges between 6 months to 12 months.

Short Duration Fund 

In this fund, the investments are made in a combination of debt and money market securities in a manner that the maturity period of the scheme ranges from 1 year to 3 years.

Medium Duration Fund 

In this fund, the investments are made in a combination of debt and money market securities in a manner that the maturity period of the scheme ranges between 3 years to 4 years.

Medium to Long Duration Fund 

 In this fund, the investments are made in a combination of debt and money market securities in a manner that the maturity period of the scheme ranges between 4 years to 7 years.

Long Duration Fund  

Under this fund option, the investments are made in a combination of debt and money market securities in a manner that the maturity period of the scheme ranges for more than 7 years.

*All savings are provided by the insurer as per the IRDAI approved insurance plan. Standard T&C Apply

Factors to Consider Before Investing in Debt Funds 

Here are some of the important factors that should be kept in mind before investing in debt funds. 

Risk Associated to Debt Funds 

There are three different types of risk associated with debt funds. These are as following:

  • Credit risk 
  • Interest Rate Risk 
  • Liquidity Risk 

The fund value may vary based on the overall changes in the interest rate. The credit risk is the default risk of the issuer for not repaying the interest and principal amount. The liquidity risk is seen in the case of lack of demand when the fund managers are unable to sell the underlying security. 

Returns

As compared to equity securities, debt fund offers lower returns. However, the returns are subject to market risks. The Net Asset Value (NAV) of debt funds fluctuates with the changes in the interest rate. In case of a rise of interest rate, the NAV of debt funds fall and vice-versa. 

Expense Ratio

This is one of the most important aspects to keep in mind while investing in debt funds. The expense ratio is the percentage of the total asset of the fund, which is applicable as a fee towards the fund management services. Since a debt fund offers a low to moderate return, the expense ratio can adversely affect the overall profit. Thus, it is important to choose the scheme with a lower expense ratio and stay invested for a longer tenure. The expense ratio limit is set by the Securities and Exchange Board of India (SEBI). 

Taxation for Debt Fund 

The taxation rule applicable to debt funds are as follows:

Capital Gain Tax 

If an investor holds the units of the debt scheme for 3 years, the capital gains earned by the investor is known as short-term capital gain (STCG). The short-term capital gain is added to the taxable income and is taxed as per the applicable Income Tax Slab. 

If an investor holds the unit of debt scheme for more than 3 years, then the capital gains earned by the investor is known as long-term capital gain (LTCG). The LTCG is taxed 20% with indexation benefits. The indexation benefit means the purchase price is increased to adjust the inflation before computing the capital gain. 

Who Should Invest in Debt Funds?

Debt funds are a lucrative option of investment for risk-averse investors and for those who don’t have proper exposure to the equity market. Let’s take a look at who should invest in debt funds. 

Investors Seeking Regular Income 

For investors who want to gain the benefit of steady and regular income along with a profitable investment return can consider investing in high-quality debt securities. 

Conservative or First Time Mutual Fund Investors 

Conservative investors or investors who are new to the market can consider investing in corporate bonds or short-duration funds as a replacement for bank fixed deposits. Along with the flexibility of withdrawal and liquidity, the investment in a debt fund generates higher returns, specifically when interest rates are low. 

Investors Willing to Park Their Money in Short-term Funds

Businesses and households can invest short-term surpluses in ultra-short duration or liquid funds rather than leaving it in a bank deposit. An overnight fund can even hold a household emergency fund while earning a profitable return. Investors with specific investment tenure can opt for an FMP (Fixed Maturity Plan). 

Investing in debt ULIP funds or debt mutual funds entirely depends on the investment objective of the investors. For individuals who don’t want to mix their investment and insurance portfolio should consider investing in debt MFs whereas, the individual who wants to gain the benefit of steady return along with the element of insurance can consider investing in Debt ULIP funds. 

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