NPS vs ELSS: Which One’s Better for Tax Saving?

Investing money is a key aspect for financial planning. Several investment options are available in the market. Regarding tax-saving investments, the National Pension System (NPS) and Equity-Linked Saving Scheme (ELSS) are two popular choices. NPS and ELSS have pros and cons, and choosing between them may be confusing. In this blog, you will read more about NPS vs ELSS and which may be better for tax saving.

What is NPS?

National Pension System (NPS) is a retirement-focused investment option regulated by the Pension Fund Regulatory and Development Authority (PFRDA). NPS is a defined contribution retirement scheme where the money is invested in various asset classes, such as equity, debt, and government securities, depending on the investor's choice. NPS offers two major types of accounts- Tier 1 and Tier 2.

Tier 1 is a compulsory account where an investor must contribute a minimum of Rs. 1,000 per year, and the maximum contribution can be at most Rs. 2 lakh per year. Withdrawals from the Tier 1 account are allowed only at retirement or in case of the investor's demise. 

A Tier 2 account, on the other side, is an optional account that can be opened only if the investor already has a Tier 1 account. The minimum contribution for the Tier 2 account is Rs. 1,000, and there is no limit on the maximum contribution. Withdrawals from the Tier 2 account are allowed anytime, and there are no restrictions on the number of withdrawals.

What is ELSS?

An Equity-Linked Saving Scheme (ELSS) is a mutual fund that invests most of its corpus in equity and equity-related instruments. ELSS is a tax-saving mutual fund which offers tax deductions under Section 80C of the Income Tax Act 1961. 

ELSS can potentially provide higher returns than traditional tax-saving investment options such as National Savings Certificate (NSC) and Public Provident Fund (PPF), but the risk involved is also higher. ELSS has a lock-in period of three years, which means an investor cannot redeem their investment before three years from the investment date.

NPS vs ELSS: A Comparison

Let us compare NPS vs ELSS based on a few parameters. After which, you can decide whether ELSS is better than NPS.

• Tax Benefits

Under the Income Tax Act, NPS provides tax benefits under Section 80C and Section 80CCD (1B). Section 80C permits an investor to claim a maximum deduction of Rs. 1.5 lakh, whereas Section 80CCD (1B) allows an additional deduction of up to Rs. 50,000. However, the entire amount received from NPS is taxable at withdrawal time.

ELSS also offers tax benefits under Section 80C of the Income Tax Act. An investor can claim a deduction of up to Rs. 1.5 lakh under Section 80C. However, at the time of redemption, ELSS funds' long-term capital gains (LTCG) are taxed at 10% if the revenues exceed Rs. 1 lakh in a financial year.

• Investment Horizon

NPS is a long-term option with a minimum investment horizon until the investor turns 60. An investor can withdraw partially from the NPS account after completing ten years of investment, subject to certain conditions.

ELSS has a lock-in period of at least three years. However, investors can continue to hold their ELSS investment beyond three years, depending on their investment goals and market conditions.

• Returns

The returns offered by NPS depend on the type of account and the asset classes chosen by the investor. In the case of the Tier 1 account, the returns are market-linked, and the asset allocation determines the scheme's performance. 

Because ELSS funds invest primarily in equity and equity-related instruments, they have the potential to provide greater returns compared to conventional tax-saving alternatives. However, the returns are not guaranteed and are subject to market risks. 

On the other hand, the Tier 2 account returns are similar to those of a savings account, with interest rates ranging from 2.5% to 6%

• Risk Profile

NPS offers a diversified investment portfolio, which includes equity, debt, and government securities. The investment in equities is capped at 50%, which means that NPS is a relatively low-risk investment option.

On the other hand, ELSS funds have a higher risk profile as they invest most of their corpus in equity and equity-related instruments. However, the risk can be managed by choosing funds with a track record of consistent performance and a diversified portfolio.

• Flexibility

NPS offers flexibility regarding investment options, such as choosing the investment option, the fund manager, and the asset allocation. Investors can also switch their investment options and asset allocation once a year.

ELSS funds offer limited flexibility as the lock-in period is three years. However, investors can choose from a wide range of ELSS funds, depending on their risk appetite and investment goals.

NPS or ELSS Which One is Better for Tax Saving?

NPS and ELSS have advantages and disadvantages, and choosing between them depends on the investor's financial goals, risk appetite, and investment horizon. Here are some points to consider while deciding on ELSS vs NPS for tax saving:

• Investment Horizon: If the investor's investment horizon is long-term, NPS may be a good option as it offers tax benefits and a pension corpus for retirement.
• Risk Profile: ELSS funds can be a good option if the investor has a high-risk appetite and is willing to take market risks for higher returns. However, investors with a low-risk appetite should consider NPS or other traditional tax-saving options.
• Flexibility: If the investor values flexibility regarding investment options and asset allocation, NPS can be a better option as it offers more investment options and allows investors to switch their investment options and asset allocation once a year.
• Liquidity: If the investor prefers liquidity and the option to withdraw their investment anytime, ELSS can be a better option as it has a shorter lock-in period of three years.

Conclusion

NPS and ELSS are both tax-saving investment options with unique features. NPS is a long-term investment option that offers a pension corpus and tax benefits, while ELSS funds provide several tax benefits and the potential for higher returns. 

Investors should choose between NPS and ELSS based on their financial goals, risk appetite, investment horizon, and liquidity requirements. It is also advisable to consult a financial advisor before making investment decisions.

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Disclaimer

The investment options and stocks mentioned here are not recommendations. Please go through your own due diligence and conduct thorough research before investing. Investment in the securities market is subject to market risks. Please read the Risk Disclosure documents carefully before investing. Past performance of instruments/securities does not indicate their future performance. Due to the price fluctuation risk and the market risk, there is no guarantee that your personal investment objectives will be achieved.