ELSS vs NPS – Which is a better investment ?
Equity Linked Saving Schemes (ELSS) and the National Pension System (NPS) are some of the commonly preferred avenues of investment to claim tax deductions. Along with tax benefits, these also give you the benefit of wealth creation through the power of compounding and exposure to equities. While these give you the dual benefit of wealth growth and tax saving, there are some important aspects to ELSS and the NPS that you would want to weigh in before investing in either.
What is an ELSS?
ELSS or Equity Linked Savings Scheme is an open-ended mutual fund scheme that maintains a diversified portfolio predominantly made up of equity shares of companies that belong to different sectors. You can invest in ELSS funds to accumulate the requisite corpus for your long term financial goals.
What is the NPS?
NPS or the National Pension System is a scheme designed to help create a retirement corpus in a systematic manner with the aim to build provisions for a regular income for your post-retirement life. Under the NPS framework, the pension fund invests your contributions into diversified portfolios that are made up of Government Bonds, Corporate Debentures and Equity Shares.
In both these cases – ELSS and the NPS – your portfolio will be managed by professional fund managers.
Let’s look at some of the differences between ELSS Funds and NPS
NPS has a different investment framework as compared to ELSS Funds.
NPS offers you two types of accounts i.e. Tier I & Tier II. The Tier I account is mandatory while you have the option to invest in the Tier II account as an add-on voluntary savings facility. In addition to this, you also get to choose between the ‘Active Choice’ and the ‘Auto Choice’ mode of fund management. In the case of ‘Active Choice’, you get to decide on the asset allocation aspect, i.e. you can choose between the asset classes and the percentage in which these need to exist in the portfolio. In the case of ‘Auto Choice’, you can pick a lifecycle option (i.e. aggressive, moderate, conservative) wherein the asset allocation gets automatically adjusted based on your age.
Also, in the NPS, your maximum allocation to equities cannot exceed 75% of the invested amount. On the other hand, in an ELSS fund, the fund manager can take an exposure of as high as 90-95% in stocks.
In the case of ELSS Funds, the investment objective of the fund determines its asset allocation and the decisions related to stock picking rests with the fund manager. You ar e not allowed to take investment bets and the fund manager decides for ELSS funds.
ELSS funds come with a lock-in period of 3 years and are considered to be the shortest as compared to other tax-saving alternatives. When you redeem your units from an ELSS Fund after the lock-in period, you receive the entire accumulated money at the NAV prevailing at that time.
On the contrary, the minimum lock-in period is much longer for the NPS where you are allowed to exit only upon attaining the age of 60. Exiting from the scheme before 60 is allowed only if you have completed a minimum of 10 years in the scheme. In such a scenario, you will receive only 20% of the fund value and you will have to purchase an annuity with the remaining 80% balance. You tend to get the whole lump sum only when the value of your fund value does not exceed Rs 1 lakh.
The NPS offers relatively less liquidity and there could be chances of you facing numerous restrictions concerning exit, the amount received on withdrawal, and its utilisation thereafter. When you exit the scheme at the age of 60, you receive only 60% of the fund value in a lump sum. You need to purchase an annuity with the remaining balance of 40% of the corpus. You will receive the full corpus on retirement only when your fund value does not exceed Rs 2 lakh. You are allowed to exit before attaining 60 years only on certain occasions like your children’s marriage, etc. In such a case, you will be required to compulsorily annuitise 80% of your retirement corpus.
ELSS funds are much more liquid in nature than the NPS. You can exit the fund any time after the lock-in period of 3 year is completed. However, to reap the full benefits, you may want to stay invested for at least 5 years or more.
When you invest in ELSS Funds, you are eligible to claim a tax deduction of up to Rs 1.5 lakh under Section 80C of the Income Tax Act. In addition to this, your capital gains up to Rs 1 lakh are tax-free. Gains on ELSS funds over and above Rs 1 lakh are subject to taxation at the rate of 10%.
You can claim a tax deduction for your contributions made in the NPS under Section 80CCD(1), subject to a ceiling of Rs 1.5 lakh. The NPS also qualifies for an additional tax benefit of Rs 50,000 under Section 80CCD(1B). This makes the overall tax benefit available under the NPS to stand at Rs 2 lakh.
Choosing between the NPS and ELSS Funds may seem like an uphill task given both their respective benefits. Undoubtedly, NPS offers higher tax-efficiency as compared to ELSS Funds, but that can’t be the only criteria to decide. When you seek to accumulate wealth for your goals, you must compare both the options based on their return potential. On that front, ELSS Funds have come out as a superior alternative to the NPS.