ELSS vs ULIP: Which is Best for NRIs?

There are a lot of investment instruments available in India when it comes to financial planning. Two very popular options that stand out for the unique benefits are the Equity-linked savings scheme (ELSS) and the unit-linked insurance plans (ULIPs).

ELSS is a type of diversified equity mutual fund that mainly invests in equity. It's popular for its tax-saving benefits and potential to offer high returns. On the other hand, ULIP is a type of financial instrument that combines the benefits of both a life insurance plan and an investment. In this blog, we will learn about the differences between ELSS vs ULIPs. We will also cover their key features, tax implications, and ideal choice for NRIs.

What is ELSS for NRIs?

ELSS (Equity Linked Savings Schemes) are a type of mutual fund that invests mainly in equities. It has a mandatory lock-in period of three years. These funds offer high long-term growth potential and come with tax-savings benefits under Section 80C of the Income Tax Act, 1961.

ELSS is suitable for both medium-term and long-term goals. You can invest any amount in an ELSS. However, contributions of only Rs. 1,50,000 will be considered for tax deductions. Additionally, you can keep investing in this scheme even after the mandatory lock-in period of three years is completed.

Key Features of ELSS

Below are some key features of an ELSS:

• Diversification: To reduce risk, investments are spread across various sectors and market capitalizations.
• Higher Returns: Based on stock market performance, it offers higher returns. However, it goes along with associated market volatility and risk.
• Tax Deduction: Investments of up to Rs. 1.5 lakh per financial year are eligible for tax deductions under Section 80C of the Income Tax Act, 1961.
• Full Redemptions: ELSS has a mandatory short lock-in period of three years, after which partial and full redemptions are allowed.
• Exposure to Equity: It offers the possibility to build long-term wealth, as at least 80% of the portfolio is invested in equity.

What is ULIP for NRIs?

A ULIP (Unit Linked Insurance Plan) is a financial product that combines life insurance with investment. A part of the investment goes towards allocating insurance coverage, and the remaining part is invested in a mix of market-linked funds like equity, debt, or balanced funds.

You can claim a tax deduction of the contribution made to a ULIP to a limit of up to Rs. 1,50,000 under Section 80C of the Income Tax Act. ULIPs (Unit-linked Insurance Plans) have a lock-in period of five years. During the lifecycle of the investment, you are allowed to switch from equity to debt or hybrid based on the objective of your investment.

Key Features of ULIPs

Below are some key features of an ULIPs:

• Tax Deductions: You can avail tax deductions for premiums up to Rs. 1.5 lakh under Section 80C.
• Tax-Exemption: Maturity proceeds are exempt from taxation under Section 10(10D) of the Income Tax Act, 1961.
• Dual Benefit: It offers both the benefits of an NRI life insurance coverage and investment opportunities.
• Flexibility: It allows switching between different funds depending on their risk appetite and market conditions, such as equity, debt, balanced, etc.
• Mandatory Lock-in: ULIPs have a mandatory lock-in period of five years; during this period, you cannot withdraw the funds.

What is the Difference Between ELSS vs ULIPs?

Consider the table below to understand the main differences between ELSS vs ULIPs:

What are the Tax Implications for ELSS and ULIP?

Understanding tax implications on ELSS and ULIP is essential, as it plays a major role when NRIs make a choice. Although both products offer tax benefits, the way the amount is taxed at exit is different. Let's understand this in detail:

Tax Benefits Under Section 80C

Both ELSS and ULIP qualify for tax deduction under Section 80C of the Income Tax Act.

• NRIs are eligible to claim a deduction of up to Rs. 1.5 lakh per financial year.
• The deduction is only provided to an NRI if he/she have taxable income in India.
• NRIs must make the investment through an eligible bank account, which is generally an NRO account (Non-Resident Ordinary).

So, both ELSS and ULIPs offer the same tax-saving benefit at the investment stage.

Tax On Maturity/Redemption

This is the point where the real difference begins.

Tax Implications on ELSS for NRIs

ELSS is treated as an equity mutual fund. So, here is how ELSS mutual fund taxation works:

• Gains earned after the three-year lock-in period are classified as long-term capital gains (LTCG).
• Long-term capital Gains are taxed at 10% on gains that exceed the limit of Rs. 1 lakh in a financial year.
• Gains up to the limit of Rs. 1 lakh are exempt from tax.

It means that ELSS is tax-efficient; however, it is not completely free from tax at the time of exit.

Tax Implications on ULIPs for NRIs

Proceeds received from ULIPs' maturity are generally exempt from taxation, provided that specific conditions are fulfilled:

• The annual premium must not exceed 10% of the assured sum.
• For new ULIPs issued after the rule change, if the premium exceeds the limit of Rs. 2.5 lakh per year. Then, the maturity amount may become subject to taxation.

If the conditions are met, both investments' returns remain exempt from taxation, making ULIPs attractive from a tax-free maturity perspective.

TDS Implications for NRIs

NRIs must also consider Tax Deducted at Source (TDS)

• ELSS (Equity-linked Savings Scheme)
  • Redemptions may incur TDS for NRIs.
  • Final tax is adjusted when the NRI files their income tax return (ITR).

• ULIP (Unit-Linked Insurance Plan)
  • Maturity redemptions are generally paid without deducting TDS if they are tax-exempt.
  • If the ULIP becomes subject to taxation (high-premium cases). Then, TDS may be applicable.

Which is Ideal For NRIs Between ELSS and ULIPs?

For most of the NRIs who have taxable income in India, and specifically those who can buy a separate term plan easily, ELSS is suitable for them. It works better as it has:

• Shorter lock-in period of three years.
• Reduced and more transparent costs without any bundled insurance charges.
• Straightforward equity taxation and TDS treatment, just like other mutual funds for NRIs.
• Easy to stop SIPs, switch funds, or rebalance as your NRI residency, DTAA position, or India plans change.

ULIPs are ideal for NRIs when:

• Your annual premium stays within the limits for section 10(10D) exemption. So, maturity can be exempt from taxation, and you value that predictability.
• You are some who genuinely wants a long-term (10-20 year) insurance + investment product in India. Also, if you are comfortable with lower liquidity.
• You prefer integrated solutions from Indian life insurers and are fine with higher complexity as well as charges.

Final Thoughts

Both ELSS and ULIPs have their unique characteristics and offer certain benefits. Choose ELSS mutual funds if your focus is on generating wealth with high growth potential and a shorter lock-in period. Furthermore, if you seek a combination of life insurance coverage and flexible investment options as per your changing needs, opt for ULIPs.

Additionally, to make an informed decision, it's essential to consult with an expert at Savetaxs. We have a team of experts who can guide you in choosing the best investment options based on your financial goals. They will also help you navigate your tax implications based on the investment option you choose so that you stay compliant. Connect with us right away and avoid any confusion about investing in India as an NRI.