ELSS Vs NPS – Which one is a better tax-saving investment?

Having a wide range of investment options always leaves the investors in a dilemma that would be a better option for them. Though the investment decisions are quite individualistic and depend on the fundamentals like liquidity requirements, long-term or short-term goals, risk appetite, etc., it is always better to brainstorm alternatives and choose the most suited one. 

In case you are looking for tax-saving investment options between ELSS and NPS, both of these are eligible for a tax deduction under 80C. Let us discuss which one would be a better alternative. 

Equity-linked Savings Scheme (ELSS) are tax-saving equity mutual funds. It invests a major portion, i.e. more than 80 to 90 per cent of the corpus into equity or equity-related instruments. According to the fund’s laid-down objective, ELSS funds invest in equity in a diversified manner across the market segments and are managed by a professional fund manager having expertise. These schemes have a mandatory lock-in period of three years; hence on redemption, these ELSS units would attract LTCG at 10% if long-term gains are more than Rs.1 lakh in one financial year. 

On the other hand, the National Pension Scheme (NPS) is a pension scheme sponsored by the government to secure individuals’ financial future after retirement. NPS is open for all the employees, including government, private, and self-employed, starting from 18 to 60 years. Under NPS, all the accumulated savings are pooled into a fund which is then invested and regulated by PFRDA (Pension Fund Regulatory and Development Authority of India). These savings are invested as per the approved investment guidelines into the diversified portfolios including government bonds and bills, Corporate Stocks and debentures. The individual can choose to allocate at a maximum 75% up to an age of 35 years. 

Please note that both the above instruments ELSS and NPS are eligible for a tax deduction of Rs 1.5 lakh under Section 80C. However, NPS offers an additional deduction of Rs 50,000 under Section 80 CCD (1B) of the Income Tax Act. 

Though both these are entirely different products, you can choose one over another or one in an excess portion of another during a financial year based on your investing goals. 

Also Read: Sensex Crosses 50,000: Missed Investing in Equity Funds?

In case your investment goal is short-term or medium-term, which means you should look for an option providing smooth liquidity. Between ELSS and NPS, ELSS clearly provides short-term liquidity with a lock-in period of just three years. On the other side, NPS allows 60% lump-sum withdrawals of the tax-free corpus and 40% as a taxable annuity, after attaining 60 years of age. NPS does provide premature partial withdrawals, but the same can be made only on meeting specified conditions. Also, the withdrawals cannot be made more than 25% of the total corpus subject to conditions. 

Apart from short-term liquidity, ELSS can also help you achieve long-term wealth creation goals. As it deploys 90-95% of its corpus in equity, and the return on investment is higher on equity in the long run than other instruments. On the contrary, NPS allows to choose equity allocation at a maximum of 75 per cent of the total portfolio, and balance is allocated towards investing in debt instruments.

Such a high level of equity allocation is available to only individuals below 35 years of age. With the increase in the age factor, the allocation in equity reduces to keep the risk profile in check. Hence, ELSS would be better positioned to provide higher returns than NPS in the long term.

Now, as we discussed the returns, ELSS seems to be at an upper pedestrian. But not to forget that the equity investments come with the inherent risk of market fluctuations. Therefore, NPS mandates to increase the allocation of funds in less risky and fixed income, providing instruments with an increase in age. Its main aim is not just wealth creation but providing a cover for retirement years. So if your intention is wealth creation with some risk appetite, ELSS would be a better go-to option against NPS and vice a verse. 

 A brief comparison between the options :

Particulars National Pension Scheme Equity-Linked Saving Scheme
Type of investment Market-linked Market-linked
Amount invested  90%-95% is invested in equity  50%  at maximum is invested in equity, rest in govt bonds, bills, treasury, etc. 
Tax on investments Tax-free up to Rs 1.5 lakh under 80C  and additional Rs 50,000 under 80 CCD (1B), total deduction of Rs 2 lakh allowed.  Tax-free up to Rs 1.5 lakh under 80C
Tax on returns The lump-sum amount at the time of maturity is tax-free. Annuities are taxable as a pension.  Returns are taxed at 10% if they exceed Rs 1 lakh
Risk Low to high based on fund selected High
Returns Moderate to high High
Payment of returns At the time of maturity, partly in a lump sum and partly in the form of annuity After three years of lock-in, lump-sum withdrawal or in instalments
Lock period Deposit tenure is till retirement, i.e.  up to  60 years Minimum of 3 years
Premature withdrawals  Up to 20% of total corpus premature withdrawals after lock-in of 3 years, or 25% in 3 instalments after 10 years for specified purposes.   No premature before 3 years,100% can be redeemed after 3 years

If the individual belongs to a lower income tax bracket and has short to medium-term liquidity requirements, ELSS would be ideal. In the case of long-term liquidity requirements, NPS would also meet the investing goals. 

For any clarifications/feedback on the topic, please contact the writer at jyoti.arora@cleartax.in

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