This question that is most often you may hear during a Tax saving season. Where should i invest for Tax saving — ELSS or NPS?
ELSS or NPS
An ELSS which stands for Equity linked saving scheme, which is a diversified equity fund that invests in equity market across the market size, and along with giving you an advantage of saving tax under sec 80c of the Income tax act. This dual advantage makes ELSS very relevant, who are seeking to grow their invested capital with Tax benefit on it.
While NPS or National pension system, on the other hand, is a Government Pension Scheme that allows you to save tax under sec 80CCD(1). It also qualifies for additional tax benefits; you may get under sec 80ccd(1b) that may go up to Rs 50,000 per financial year.
About NPS (National pension system)…
At first, when it was introduced, it was not tax friendly due to its rigid rules. However, over the last 10 decades, the government has provided more tax advantages, relaxed investment norms and made withdrawals more lenient. Nevertheless, investors are not thronging to invest in NPS. In accordance with ETwealth, in a country like India, we have 1.24 crore NPS subscribers, and among them,17 lakhs are who are investing in it voluntarily. It is mandated by government for central or state govt employee to invest in NPS or National pension system.
In the long term, it is already proven that Equity or market-linked investments have the probability of giving you best return in your kitty. This makes mutual funds the most obvious choice. However, along with NPS, you can participate in equity up to 75% and rest corpus goes to debt allocation in the portfolio, that provides you with a cushion to tide over the market volatility.
Here are some comparisons between NPS or ELSS on 5 different parameters. Read more to know which may come more beneficial for you.
Elss funds being a pure equity fund maintains a high exposure ( over 80-90%) to equity throughout the year while NPS investors have the option to allocate up to 75% in equity.
Also, this 75% in equity component gradually shift into Debt instrument depending on the investor’s age.
That is why— ELSS funds could give you higher returns in the long term as compared to NPS investors. However, in the short term, this picture might be different.
If you compare the last 1 year, then you may find ELSS have given only 4-5% return, while in the NPS, equity funds provided double-digit returns to its investors. That is because ELSS invest in all market cap. Even, the most conservative Elss equity funds have about 10-15% allocation to small and midcap stocks. On the other hand, NPS equity funds have a pre-decided allocation to large cap.
That’s why Correction in small and mid-cap space in ELSS have pulled down their returns while Large cap oriented NPS equity funds have done well in the last 1 year. However, in the long term, this may change. The go anywhere approach of the ELSS funds has the potential to beat market returns with a good margin.
Tax treatment of both NPS and ELSS has changed a lot in last some years.
As earlier Long term capital gains generated from equity funds were tax-free, but now over 1 lakh it is taxed at 10%. Similarly, taxability structure in the NPS took a leap forward but in the opposite direction. Earlier, only 40% withdrawal corpus at the time of retirement was tax-free, and 20% was taxable at the normal rates. Now, the entire corpus of 60%, at the time of your retirement will be tax-free.
However, the 40% remaining amount at the time of retirement will be put int an annuity and will be fully taxed as pension income, according to your tax slab.
Furthermore, NPS subscribers will get an additional tax advantage up to Rs 50,000 in sec 80CCD(1B). This is a welcome step for 30% tax payer, wherein they will save additional tax saving of Rs 15,600.
As mentioned above, ELSS fund invests in equities, while NPS invests in a mix of stocks, corporate bonds, government securities. Investors in the NPS can choose their own asset mix as per their risk appetite. Otherwise, they could go with a life cycle fund option, wherein asset mix changes according to their age, it gradually shifts your entire corpus out of equity into debt.
Additionally, ELSS comes with a statutory lock-in period for 3 years. Even if, the fund is not performing well, or market is looking jittery, you can’t touch the money for the next 3 years while NPS allows you to switch the pension fund or asset allocation, though only 2 switches are allowed in a financial year.
There’s another difference. An individual can spread his investment across ELSS scheme as many as he wants, an individual can start a Sip with as little as Rs 500 per month. On the other hand, NPS does not allow to diversify the invested amount. An investor has to go with the single pension fund manager for the entire corpus.
ELSS comes with a mandatory lock-in period of 3 years, and an investor can withdraw their funds once the lock-in period is over. On the other hand, the lock-in period in the NPS has much longer. An investor can withdraw the amount from NPS at the time of his retirement only or if he turns out to be 60 years, whichever comes first.
However partial withdrawals are allowed, but that is allowed for a specific reason like child marriage, for child higher education or at the time of critical illness. But only three withdrawals are allowed for the entire duration, and that too, if you have completed three years in the NPS.
And, also on redemption, only 60% of the entire corpus can be withdrawn, for the remaining part of 40%, compulsorily have to put in an annuity to get a monthly pension. Thus, 40% of the invested amount is not available upon retirement.
Well, these restrictions on withdrawal is a plus point for investors. Equity could create wealth for its investor only if they stayed invested over a period of time. if you used to dip into your savings for unnecessary expenses, then NPS comes out as a Good companion for the long term.
Mutual funds have a fairly simple cost, which we have known as TER (Total expense ratio). This is a percentage form which is charged on the fund and gets deducted from the Fund nav daily. This comprises of all the expenses of Mutual fund company like administrative expenses, fund managers fee, operational expenses, Custodian fee. For the regular plan, it may go up to 2-2.5% annually. However, for Direct plan wherein one can start investing without a distributor, and need not- to pay any commission.
Although Direct plan in the mutual fund does come not much costly to investors, it may not match the ultra-low-cost structure of the NPS, wherein mere 0.01% fee is charged annually.
What investors should do:
After knowing all the details mentioned above, we can safely conclude that Equity as an asset class could be a wealth generator for an investor.
But, that’s only possible if one stayed invested in all market time frame. And, ELSS does not save your tax only but also giving you an advantage of capital growth. In addition to this, if you come in the higher tax bracket and your 80c limit is already exhausted, then you may think of NPS, wherein under sec 80ccd(1b), you may start investing upto Rs 50,000 and could save additional tax of Rs 15,600.