ELSS vs. NPS: Read on to understand the role played by equity and pension in tax planning

When it comes to tax planning, equity-linked savings scheme (ELSS) and the National Pension System (NPS) are two popular investment options among Indian taxpayers. Both ELSS and NPS offer tax benefits while providing avenues for wealth creation and retirement planning. Discussed here is an elaboration on the significance of ELSS and NPS, highlighting their individual features and benefits. Additionally, compared are the two investment options, emphasising their roles in tax planning.

What is ELSS?

What is ELSS? This is a major question that many may have, particularly the new age tax savers. ELSS is a mutual fund scheme that primarily invests in equities, offering the dual benefit of tax savings and long-term capital appreciation. Under Section 80C, an investment of up to Rs. 1.50 lakh in ELSS qualifies for tax deduction. ELSS has a lock-in period of three years, which is the shortest among all tax-saving investment options.

Reasons to invest in ELSS

Flexibility and liquidity

ELSS has considerably a short lock-in term period equalling three years, offering you as an investor with liquidity and flexibility. Post lock-in period completion, investors get the choice to either continue or liquidate their units with the investment.

Potential for higher returns

ELSS invests predominantly in equities, which have the potential to deliver higher returns over the long term. For example, Mr. Sharma invested Rs. 1 lakh in an ELSS fund five years ago and realised a return of 15% per annum. His investment grew to Rs. 1.95 lakh, outperforming other traditional tax-saving instruments.

Systematic investment

ELSS allows investors to invest through systematic investment plans (SIPs). This enables them to invest smaller amounts at regular intervals, reducing the burden of a lump sum investment. For instance, Ms. Patel invested Rs. 5,000 per month in an ELSS fund through an SIP for three years, accumulating a substantial corpus while benefiting from rupee cost averaging.

Wealth creation and diversification

By investing in ELSS, individuals can create long-term wealth while diversifying their investment portfolio. For example, Mr. Khalid allocated a part of his ELSS investment, which assisted him attain capital growth and diversify his holdings over the customary fixed-income investments.

Long-term capital gains (LTCG) and tax-free dividends

ELSS provides long-term capital gains and tax-free dividends. Dividends received from ELSS are tax-exempt, and capital gains realised post the completion of lock-in period of 3 years are free of tax.

What is NPS?

NPS is a government-sponsored pension scheme designed to provide retirement income to individuals. It offers a tax-efficient way to accumulate a retirement corpus. Contributions to NPS qualify for tax deductions as per Section 80 C, subject to the highest limit of Rs 1.50 lakh. Moreover, an exclusive benefit in tax of up to Rs 50,000 as per Section 80 CCD (1b) is available for NPS investments.

Reasons to invest in NPS

Tiered structure

 NPS provides distinct investment choices called asset classes, permitting retail investors to select their desired return and risk level. Such asset classes involve corporate bonds, government securities and equity. Retail investors can invest their contributions throughout such asset classes depending on their investment goals and risk appetite.

Retirement planning

NPS is specifically designed to help individuals build a retirement corpus. By investing regularly over the long term, individuals can accumulate a substantial retirement fund to support their post-retirement financial needs.

Professional fund management

NPS are managed by expertise fund managers appointed by PFRDA (Pension Fund Regulatory and Development Authority). Such fund managers hold the expertise to make investment decision on the investor’s behalf, with the aim to optimise their returns while managing potential risks.

Additional tax deduction

Apart from the regular Section 80C benefit, NPS offers an additional tax deduction of up to Rs. 50,000 under Section 80CCD(1B). This exclusive NPS tax benefit allows taxpayers to avail an additional tax deduction over and above the Rs. 1.50 lakh limit, thereby reducing their tax liability further.

Tax efficiency

NPS provides tax benefits at the time of investment and maturity. While contributions are eligible for tax deductions, the maturity amount is partially tax-free. Additionally, NPS offers the flexibility to withdraw a portion of the accumulated corpus at retirement, subject to certain conditions.

Comparative analysis between ELSS and NPS

Lock-in period

ELSS has a lock-in period of three years, while NPS has a lock-in until the age of 60. This makes ELSS more suitable for short-term goals, such as tax savings, whereas NPS is ideal for long-term retirement planning.

Risk and return

ELSS fund predominantly invests in the equities, which carry major risks but even provide the potential for generating higher returns. In contrast, NPS offers a range of various asset classes, involving fixed-income instruments and equities, permitting retail investors to select their risk profile.

Tax planning

Both ELSS and NPS offer tax benefits. Investments in ELSS qualify for deductions under Section 80C, while NPS provides deductions under both Section 80C and an additional benefit under Section 80CCD(1B).

Retirement corpus

While ELSS primarily focuses on wealth creation and tax savings, NPS is specifically designed to build a retirement corpus. NPS offers the advantage of disciplined contributions and a retirement-focused investment approach.

Flexibility and liquidity

ELSS offers relatively more flexibility and liquidity due to its shorter lock-in period. NPS, on the other hand, has a longer lock-in period until retirement, but it allows partial withdrawals under specific circumstances.

Conclusion

ELSS and NPS are two tax-efficient investment options that play a vital role in tax planning while providing avenues for wealth creation and retirement planning. By investing in both ELSS and NPS, individuals can spread their investments and attain the benefits of diversification. Additionally, investing in NPS offers an additional tax deduction benefit of up to Rs. 50,000, further reducing the tax liability. It is crucial to consider individual financial goals, risk tolerance, and investment horizon before making investment decisions. Consulting a financial advisor can help individuals make informed choices and optimise their tax planning strategies while benefiting from the potential of ELSS and NPS.