NPS vs ELSS

Saving tax is one of the important aspects of financial planning and wealth creation. There are various avenues available where an individual can invest to save taxes. Among them, Section 80C has a list of investments that offer tax deductions up to Rs. 1.5 lakh. Here, in this article, we will discuss in detail two popular schemes NPS vs ELSS and the differences between them. 

What is NPS National Pension Scheme?

National Pension Scheme or NPS is a social security and voluntary initiative by the central government. It is a voluntary retirement plan suitable for a long term investment horizon. This scheme is regulated by the Pension Fund Regulatory and Development Authority (PFRDA) and the Central Government. This scheme is available to all employees of the economy, including private, public and unorganised sectors. 

The NPS scheme encourages individuals to start saving for their retirement to build a sufficient corpus. Upon retirement, investors can withdraw a certain percentage of their corpus and invest the remaining amount in an annuity. They will receive an amount every month as a pension. PFRDA offers various annuity schemes for investors to choose from. 

NPS offers two types of accounts, i.e. Tier I and Tier II accounts. The Tier I account is mandatory and a basic form of an NPS account. At the same time, Tier II accounts are voluntary. Also, Tier I accounts have a lock-in period until the retirement age of the investor. Furthermore, only Tier I subscribers can open a Tier II account. Moreover, Tier II accounts do not have any lock-in period or withdrawal restrictions. 

Investment in NPS qualifies for tax deduction up to Rs. 1.5 lakh under Section 80C of the Income Tax Act, 1961. Also, an additional amount of Rs. 50,000 qualifies for deduction under Section 80 CCD of the Income Tax Act, 1961. 

Who Should Invest in NPS?

The National Pension Scheme (NPS) aims to provide financial stability post-retirement. This scheme is suitable for investors with a lower risk tolerance level and who want to plan for their retirement. Also, the NPS scheme has a special tax advantage where investors can claim a tax deduction of up to Rs. 2 lakh, combining Section 80C and 80CCD. 

A part of the NPS corpus goes into equities, and the equity is exposed to market fluctuations and hence does not guarantee returns. Moreover, NPS schemes can offer better returns in comparison to other tax saving schemes.  Also, it gives investors an option to change the fund manager if they are not satisfied with the fund performance. Hence, the investor can decide to invest in NPS depending on their financial objective, cost of living and earnings, and risk tolerance levels. 

What is an ELSS?

ELSS or Equity Linked Savings Scheme is an open-ended mutual fund scheme that predominantly invests in equity and equity-related instruments, allowing investors to save tax. Investment in ELSS serves both the purpose of saving taxes and creating wealth in the long run. The returns generated from this scheme is market-linked and hence, does not guarantee returns. Lately, ELSS funds have become popular among investors as they can generate higher returns than traditional tax-saving instruments. This scheme is more suitable for investors with a long term investment horizon. 

Compared to other tax-saving instruments, ELSS funds have the lowest lock-in period of 3 years. Also, investors can claim tax deductions up to Rs. 1.5 lakh under section80C of the Income Tax Act,1961. Also, it helps investors in getting a diversified portfolio by investing as low as Rs. 500 per month. 

Who Should Invest in ELSS?

ELSS funds are suitable for those investors who want to save taxes under Section 80C. However, ELSS funds have certain risks attached to them as they have equity exposure in their portfolio, and the performance of the fund is market-linked. Thus, ELSS funds can be best suited for investors who understand equity asset class risk. Also, these funds offer better returns in comparison to other traditional tax saving schemes. Investors with a long term investment horizon can consider investing in ELSS funds. Furthermore, ELSS funds have the lowest lock period among the other asset classes that qualify for deduction under Section 80C. 

Investment in ELSS schemes offers portfolio diversification to investors. Also, these tax saver funds have dedicated fund managers to monitor the portfolio continuously. Even small investors can save taxes by investing in ELSS mutual funds through monthly SIPs. They can start with a small amount as low as Rs. 500 every month. 

Difference Between NPS and ELSS

The structure of NPS and ELSS mutual funds is very similar, where both pool assets from investors and assign or allot units as investment value in a fund. The money which gets collected is invested as per the predetermined asset allocation. The portfolio is actively managed by a fund manager who endeavours to grow the investor’s money and give reasonable returns in the long term. 

Below is the complete view on NPS vs ELSS funds, the appropriate parameters to differentiate between NPS and ELSS mutual funds. 

Minimum Investment

The minimum contribution amount required for the Tier I account is Rs. 1000 and Rs.250 for the Tier II account. On the other hand, the minimum investment in ELSS funds is Rs. 500 as SIP or lumpsum. 

Lock-in Period

The NPS investment is locked in until retirement age or 60, whichever is earlier.  Currently, investors can also extend their NPS account till 70 years of age. Therefore, investors cannot redeem their money before completing at least 10 years or reaching 60 years. However, partial withdrawals are allowed for very specific reasons subject to 25% as the upper limit. On the contrary, ELSS mutual funds have a lock-in period of 3 years which is the lowest among all tax-saving instruments. 

Portfolio Asset Allocation

In NPS, the corpus is invested partially in equity and partially in corporate debt, government securities and alternative investment funds. In contrast, ELSS funds predominantly (at least 80%) invest in equity. Therefore, ELSS funds have a higher potential to generate higher returns than NPS. 

Risk

ELSS funds have higher exposure towards equity in comparison to the NPS scheme. Thus, the risk associated with ELSS investment is also high. However, the risk factor also depends on how much risk is the investor ready to bear. Also, these funds are actively managed by a professional fund manager. A fund manager ensures and aims for substantial returns for the mutual fund portfolio. 

Cost

The management fee for NPS is 0.1% which is the lowest cost managed fund for retirement planning. On the other hand, the asset management companies charge an expense ratio ranging from 0.5% to 1.50%, which is much higher than the cost of management of NPS. 

Transparency 

ELSS mutual funds are more transparent than NPS as they disclose their asset allocation every month through factsheets on their website. This enables the investors to compare the fund holding across different sectors for different funds. However, in NPS, there is no such transparency concerning asset allocation. 

Taxation

Investment in NPS has a provision to give investors a higher tax deduction of up to  Rs 2 lakh under sec 80C as compared to Rs 1.5 lakh for ELSS schemes. Upon retirement, NPS has an advantage where subscribers can withdraw a maximum of 60% of their total corpus as a lump sum, and the remaining 40% is exempted from tax. 

The remaining amount must be invested in an annuity that gives regular income for the rest of life. This amount is exempt from tax, even though the income received from the annuity is taxable at the applicable slab rate. 

Both the investment options offer tax benefits to investors. However, NPS offers greater tax benefits in comparison to ELSS funds. Also, ELSS funds are taxable for the long term gains at 10% over Rs. 1 lakh. 

Flexibility

For an NPS account, it is mandatory to open a Tier I account that restricts withdrawals. Also, subscribers cannot redeem their entire investment before completing at least 10 years or attaining 60 years of age. However, partial withdrawals are allowed on fulfilling the conditions subject to an upper limit of 25%. Hence, there is no flexibility in the investment. 

Over the long run, investors should diversify their portfolios by having fixed income exposure as the entire corpus is only invested in equities. However, in a long period of 10-20-30 years, equities tend to deliver inflation beating returns. 

ELSS funds are more flexible in terms of choosing options, schemes and investment horizons. Also, after 3 years of the lock-in period, investors can exit the scheme partially or fully or continue to stay invested as long as they want. 

Key Takeaways on NPS vs ELSS

Before investing in any scheme, you need to list down your financial goals and objectives. Then define your investment horizon. And finally, align your goals with investment objectives. Then you can pick the investments which suit you the best, 

ELSS funds are good for both short term and long term goals. Also, they offer higher returns than NPS. However, they have a higher risk than NPS too. Unlike NPS, ELSS funds have a lower lock-in period of 3 years, and investment qualifies for tax deduction under 80C. 

NPS is more suitable for long term goals like retirement planning. Unlike ELSS, they tend to offer stable returns. However, the NPS scheme has a lock-in period until 60 years. Also, investment in NPS qualifies for tax deduction under Section 80C and 80CCD of the Income Tax Act. 

Therefore, as an investor, you should first set your financial goals and based on that, you can decide which investment suits you the best. You can also take the help of financial advisors to pick the best investment suitable for you. 

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