Mutual Funds vs ULIP: Cost, Return and Tax Compared

If you have a salary account with a private bank, you have almost certainly been offered a ULIP. The pitch is attractive: market returns, life cover and tax-free maturity in one product. The comparison that actually matters is mutual funds vs ULIP on cost, return and tax, because that is where the difference shows up in your final corpus.

ULIPs today are not the high-commission products of 2008. IRDAI has capped charges, many online ULIPs carry no premium allocation charge, and since September 22, 2025, individual life insurance including ULIPs is exempt from GST. At the same time, ULIP maturity is no longer tax-free for everyone. Policies with annual premium above Rs. 2.5 lakh are taxed like equity mutual funds.

In this guide, we break down every ULIP charge, compare it with mutual fund costs, explain tax at entry and exit under both regimes, and run a 15-year rupee comparison so you can see which option leaves you with more money.

Mutual Funds vs ULIP

Here is how the two compare on cost, return, tax and flexibility in 2026.

In short, ULIPs bundle insurance and investment and win on tax-free switching. Mutual funds are cheaper, more liquid and more transparent.

What is a ULIP and How Does It Work

A Unit Linked Insurance Plan is a life insurance policy where part of your premium buys life cover and the rest is invested in market-linked funds of your choice. Like a mutual fund, your money is converted into units, and the value of those units moves with the market.

Every ULIP has three moving parts:

1. Life cover: Usually 10 times the annual premium if you are below 45. If you die during the policy term, your nominee gets the higher of the sum assured or the fund value.
2. Fund options: Typically equity, balanced, debt and liquid funds. Many insurers also offer index and mid-cap funds.
3. Charges: Deducted either from your premium or by cancelling units from your fund every month.

The minimum lock-in is 5 years. You can stop paying after 5 years, make partial withdrawals, or continue until maturity, which is usually 10 to 20 years. If you stop paying premiums before 5 years, the policy is discontinued and your money moves to a discontinued policy fund that earns a low return until the 5-year lock-in ends.

Two changes make 2026 ULIPs different from older ones. First, IRDAI’s 2024 product regulations improved surrender values. Second, individual life insurance premiums have been exempt from GST since September 22, 2025, which removed the 18% GST that used to be charged on ULIP charges such as mortality and policy administration.

What Mutual Funds Offer Long-Term Investors

A mutual fund pools money from investors and invests it according to a stated mandate, such as large-cap equity, flexi-cap or short-term debt. You buy units at the day’s NAV and can redeem them on any working day.

For a long-term goal like retirement or a child’s education, most salaried professionals use a monthly SIP in equity index funds, flexi-cap funds or hybrid funds. If you are in the old regime and want a tax deduction, ELSS funds qualify under Section 80C with a 3-year lock-in.

Mutual funds have no insurance component. If you choose mutual funds over a ULIP, you buy your life cover separately through a pure term plan. This “term plan plus mutual fund” combination is the fair comparison with a ULIP, and it is the one we use throughout this article.

Difference 1: Cost Structure

Cost is where mutual funds vs ULIP differ the most. A mutual fund has one main cost. A ULIP has six, and they are deducted in different ways.

ULIP charges explained

IRDAI also caps the total impact of charges through a limit on the reduction in yield, so a ULIP held to maturity cannot be as expensive as the ULIPs of the 2000s. Still, the mortality charge is a real cost that mutual funds simply do not have, and it increases as you age.

Mutual fund costs

A mutual fund’s cost is its Total Expense Ratio (TER), adjusted daily in the NAV. A direct plan of a Nifty 50 index fund typically costs 0.1% to 0.3% a year, and an active flexi-cap fund in direct plan costs 0.5% to 1%. There is usually an exit load of around 1% only if you redeem within the first year.

What the cost gap does over time

A total cost of around 1.8% a year in a low-cost online ULIP versus 0.3% in an index fund is a gap of 1.5%. On yearly investments over 15 years at an 11% gross return, that gap reduces the final corpus by about 12%. In an agent-sold ULIP with a premium allocation charge, the gap is wider.

What this means in practice: Always ask for the benefit illustration and check the “net yield” at 8% assumed gross return. The difference between 8% and the net yield shown is your real annual cost.

Difference 2: Returns and What Drags Them

Both products invest in the same markets, so the gross return of a ULIP equity fund and a similar mutual fund can be close. What you actually earn is the gross return minus costs, and that is where they part ways.

Three factors pull ULIP returns down compared with a mutual fund:

• Mortality charge: Part of every ULIP pays for life cover. That money is not invested.
• Early-year charges: In agent-sold plans, premium allocation charges reduce the amount invested in years 1 to 5, when compounding has the most time to work.
• Limited fund choice: Most insurers offer 5 to 10 funds. A mutual fund investor can choose from hundreds of schemes across over 40 fund houses, including low-cost index funds.

One factor works in favour of ULIPs: tax-free switching. You can move from equity to debt inside a ULIP without paying capital gains tax. In mutual funds, moving from an equity fund to a debt fund is a redemption, and gains above Rs. 1.25 lakh in a year are taxed at 12.5%. For someone who rebalances actively, this advantage is real.

There is also a behavioural angle. The 5-year lock-in and the habit of paying an insurance premium keep some investors invested through market falls. A mutual fund investor who stops SIPs in a downturn can lose more than the cost difference. Neither product guarantees returns, and past performance of either does not guarantee future results.

Difference 3: Tax Benefit on Investment (Old vs New Regime)

At the time of investing, both products get the same treatment: a deduction under 80C in the old regime, and nothing in the new regime.

So under the old regime, ELSS and ULIP both use the same Rs. 1.5 lakh 80C limit, which most salaried employees already fill with EPF, life insurance and children’s tuition fees. Under the new regime, which is now the default, neither gives any benefit at entry.

If you are deciding between regimes, our old vs new tax regime guide walks through the calculation with salary examples. Note that under the Income Tax Act 2025, Section 80C becomes Section 123 from Tax Year 2026-27; the benefit continues.

Difference 4: Tax on Maturity and Withdrawal

This is the area where ULIPs still hold a genuine edge for most salaried investors, as long as you stay under the Rs. 2.5 lakh limit.

ULIP maturity tax

• Aggregate annual premium up to Rs. 2.5 lakh: Maturity proceeds are fully tax-free under Section 10(10D), provided the premium in any year does not exceed 10% of the sum assured.
• Aggregate annual premium above Rs. 2.5 lakh (policies issued on or after February 1, 2021): Maturity proceeds are not exempt. Since Budget 2025 clarified the treatment, gains on such equity-oriented ULIPs are taxed like equity mutual funds: 12.5% LTCG above Rs. 1.25 lakh if held over 12 months, and 20% STCG otherwise.
• Death benefit: Always tax-free for the nominee, whatever the premium.
• Policies issued before February 1, 2021: The Rs. 2.5 lakh limit does not apply.

The Rs. 2.5 lakh limit is aggregate. If you hold two ULIPs with premiums of Rs. 1.5 lakh each, together they cross the limit, and only one of them can be treated as exempt. Budget 2026 did not change these rules, even though industry bodies had asked for the limit to be raised to Rs. 10 lakh, as Upstox reported.

Mutual fund withdrawal tax

• Equity funds held over 12 months: 12.5% on long-term gains above Rs. 1.25 lakh in a financial year (Section 112A).
• Equity funds held 12 months or less: 20% on short-term gains (Section 111A).
• Debt funds bought after April 1, 2023: Gains taxed at your slab rate.

Budget 2026 kept these rates unchanged.

Where the gap narrows

Mutual fund investors can reduce tax significantly. By redeeming and reinvesting up to Rs. 1.25 lakh of long-term gains every year (tax-gain harvesting), or by withdrawing through an SWP, you can keep much of the gain tax-free. So the real tax advantage of a ULIP under Rs. 2.5 lakh is smaller than the headline “tax-free maturity” suggests.

Difference 5: Lock-in, Liquidity, Switching and Insurance Cover

The insurance part needs a closer look. A ULIP with Rs. 1.5 lakh annual premium gives about Rs. 15 lakh of cover. For a 30-year-old earning Rs. 15 lakh a year, a sensible cover is Rs. 1 crore to Rs. 1.5 crore. A pure term plan for Rs. 1 crore costs a non-smoker of that age roughly Rs. 10,000 to Rs. 15,000 a year. So a ULIP rarely gives you adequate life cover, and you usually need a term plan anyway.

That is why the fair comparison is not ULIP vs mutual fund, but ULIP vs term plan plus mutual fund.

Worked Example: Rs. 1.5 Lakh a Year for 15 Years

Priya is 30, works in Pune, and earns Rs. 15 lakh a year. She is in the new tax regime, so neither option gives her a deduction. She has Rs. 1.5 lakh a year to invest for 15 years and wants life cover as well. She compares three routes.

Assumptions: Gross market return of 11% a year for all options. Low-cost online ULIP with total charges of about 1.8% (net 9.2%). Agent-sold ULIP with premium allocation charges in early years (net about 8%). Direct index fund at 0.3% cost (net 10.7%). Term plan premium of Rs. 12,000 a year for Rs. 1 crore cover.

What the numbers show:

• A low-cost online ULIP, held for the full term and under the Rs. 2.5 lakh limit, comes surprisingly close to the mutual fund route on post-tax corpus. Tax-free maturity offsets most of the cost gap.
• An agent-sold ULIP with early charges falls Rs. 3.5 lakh to Rs. 7 lakh behind the mutual fund route.
• The term plan plus mutual fund route gives Rs. 85 lakh more life cover throughout the 15 years, full liquidity from day one, and a slightly higher corpus if Priya harvests gains every year.

What changes if the premium crosses Rs. 2.5 lakh? If Priya invested Rs. 3 lakh a year in ULIPs, maturity would be taxed like an equity fund, about Rs. 6.7 lakh on a Rs. 97.7 lakh corpus. The ULIP’s tax advantage disappears, but its higher cost remains. At that level, mutual funds are clearly better.

These figures assume identical gross returns, which will not happen in reality. Treat them as a comparison of cost and tax structure, not a forecast.

Mutual Funds vs ULIP: Which is Better for Whom?

Already Holding a ULIP: Continue or Surrender?

Many readers already hold a ULIP bought a few years ago. Switching to mutual funds is not always the right move, because most of the ULIP’s costs are front-loaded.

1. Within the first 5 years: Surrendering means a discontinuance charge, your money sits in a low-return fund till year 5, and any 80C deduction claimed earlier is reversed. Usually, it is better to complete 5 years of premium.
2. After 5 years, low-cost plan, premium under Rs. 2.5 lakh: The expensive years are behind you. Continuing often makes sense, especially if maturity is tax-free.
3. After 5 years, high charges or poor fund options: You can stop paying premiums and let the fund continue, or make partial withdrawals, and direct fresh savings to mutual funds.
4. In all cases: Check whether your life cover is adequate. If not, buy a term plan first; do not wait for the ULIP to mature.

Before surrendering, ask the insurer for the current fund value, surrender value and any pending charges in writing.

Common Mistakes to Avoid

• Treating a ULIP as your life insurance. Ten times the annual premium is rarely enough cover. Buy a term plan separately.
• Ignoring the aggregate Rs. 2.5 lakh limit. Two or three ULIPs can together cross it and make maturity taxable.
• Comparing ULIP fund returns with mutual fund returns directly. ULIP fund NAV returns exclude mortality and policy charges deducted through unit cancellation. Compare net yield from the benefit illustration.
• Stopping ULIP premiums in year 2 or 3. This locks in the highest charges and the lowest returns.
• Buying regular plans of mutual funds for a 15-year goal. If you choose mutual funds for the lower cost, use direct plans.
• Assuming ULIP maturity is always tax-free. It is tax-free only within the premium and sum assured conditions.
• Redeeming mutual funds all at once at maturity. Harvest Rs. 1.25 lakh of gains every year, or withdraw through an SWP.

Frequently Asked Questions

Which is better, mutual funds or ULIP, in 2026?

For most salaried professionals, a term plan plus mutual funds is better because it gives higher life cover, lower cost and full liquidity. A low-cost online ULIP can be competitive if you already have adequate term cover, invest under Rs. 2.5 lakh a year and hold it for 10 years or more.

Is ULIP maturity tax-free in 2026?

Yes, if the aggregate annual premium across your ULIPs is up to Rs. 2.5 lakh and the premium does not exceed 10% of the sum assured. For policies issued on or after February 1, 2021 with higher premiums, gains are taxed like equity mutual funds.

What are the charges in a ULIP?

Premium allocation charge, policy administration charge, fund management charge (capped at 1.35% a year), mortality charge, discontinuance charge and switching or partial withdrawal charges beyond free limits.

Is there GST on ULIP charges now?

No. Individual life insurance, including ULIPs, has been exempt from GST since September 22, 2025. Earlier, 18% GST applied to ULIP charges.

Can I claim 80C on ULIP under the new tax regime?

No. 80C deductions, including for ULIP premiums and ELSS, are available only under the old regime.

Is switching between ULIP funds taxable?

No. Switching between funds within a ULIP is not treated as a sale, so there is no capital gains tax. In mutual funds, every switch is a redemption and can be taxed.

What happens if I stop paying ULIP premiums?

If you stop within the first 5 years, the policy is discontinued, a discontinuance charge applies, and the money moves to a discontinued policy fund until the lock-in ends. After 5 years, you can usually continue with reduced benefits or surrender without a discontinuance charge.

Written & Reviewed by

Diksha Chawla

Financial Educator & Content Creator | FinLecture.in

Diksha covers Indian income tax, mutual funds, ITR filing, and personal finance. FinLecture content is cross-checked against official government portals and SEBI/AMFI guidelines.

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