ELSS vs PPF: Which is the better tax saving option?

So you want to take advantage of Section 80C of the Income Tax Act and make investments that help you reduce your income tax burden. You have several options, and among the two most popular ones are Equity Linked Savings Schemes (ELSS) and the Public Provident Fund (PPF). You can claim deductions from taxable income up to Rs. 1.5 lakh in a financial year by investing in either ELSS or PPF.

But this is where the similarity ends. ELSS and PPF are very different in terms of their tax benefits, risk profile, returns and tenure. So let’s look at each of these characteristics in turn.

ELSS vs PPF – A comparison

Tax benefits

As we mentioned earlier, investments under both ELSS and PPF are eligible for a deduction in taxable income up to Rs. 1.5 lakh in a financial year. But things are a little different when it comes to taxation on the returns on these two instruments.

PPF is what is called an EEE (exempt, exempt, exempt) scheme. That is to say, the amount invested, interest earnings and the final corpus on maturity are all exempt from tax.

Returns on ELSS, on the other hand, are subject to tax on redemption. If you sell ELSS funds after three years, you will have to pay long-term capital gains (LTCG) tax of 10% if LTCG gains are over Rs. 1 lakh in a financial year. 

Risk profile

PPF is a government-backed scheme and therefore perfectly safe. It’s the main reason why so many cautious investors prefer to invest in this scheme. On the other hand, ELSS funds invest in equity, which is subject to market fluctuations. So there are no guaranteed returns here. ELSS returns depend on the stock market performance.

Returns

Interest rates on PPF are fixed by the government from time to time, and are usually somewhat higher than the rate offered on bank fixed deposits. At the moment of writing (Dec, 2020), the interest rate was 7.1%. This is an excellent rate of return on what is a risk-free investment.

As we mentioned earlier, the fortunes of ELSS funds depend on the state of the stock market. But going by past experience, returns are expected to be much higher than those on PPF and other fixed-income investments. As a matter of fact, equity has outperformed most other asset classes in the past few years. But of course, past returns are no guarantee of future profits.

Tenure

PPF has a fairly long lock-in period of 15 years, so you need to have a longer investment horizon to invest in this scheme. However, you can make partial withdrawals of up to 50% from the seventh year. There’s also a provision for loans from your PPF account, which can be availed by paying an interest of 1% more than the deposit rate. Of course, by staying invested in PPF for such a long time, you enjoy the benefits of compounding and get a fair-sized corpus on maturity.

ELSS, on the other hand, has a lock-in period of only three years, the shortest among similar tax-saving instruments. This is attractive for those who don’t want to lock in their funds for long periods. However, it would be a good idea to remain invested longer, since equity investments yield the best results if you stay invested for at least five years.

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