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NPS or ELSS: Which one is better for tax saving?

Introduction

Managing taxes is an essential skill that you should master. And once you master it, you can plan your finances more effectively. While tax savings can be realized under many sections of the Income Tax Act, this article will focus on two popular ones - the National Pension Scheme (NPS) and Equity Linked Savings Scheme (ELSS).

Additional read: Tax Saving options beyond Section 80C

What is National Pension Scheme?

National Pension Scheme or NPS is a pension scheme that the government sponsors. It encourages individuals to save towards a retirement goal. Employees in public, private and unorganized sectors can invest in this scheme. However, it is not available for people in the armed forces.

There are two types of accounts offered under NPS – Tier I accounts and Tier-II accounts.

Tier I accounts are a primary type of NPS account and are mandatory to invest in. You can choose the different types of funds based on asset allocation as per your investment objective and risk appetite. They have a lock-in period until the age of retirement. Withdrawals are permitted only after a certain period and are subject to limitations. Tier-II accounts are voluntary accounts. However, you need to invest in a Tier I account to open a Tier II account. In addition, Tier II accounts do not have lock-in periods or withdrawal restrictions.

Investments in NPS are eligible for tax deduction under Section 80CCD (1) and 80 CCD (1B) of the Income Tax Act.

What is Equity Linked Savings Scheme?

The Equity Linked Savings Scheme or ELSS is a tax-saving mutual fund that invests most of its funds in equity and equity-related investments. They have a lock-in period of three years which is the lowest among all other tax saving instruments. While they can be withdrawn after three years, they are better suited as long-term investments. Investment in ELSS are eligible for tax deduction under Section 80C of the Income Tax Act.

Additional Read: What are tax saving mutual funds and how do they work?

Tax Deductions

Contributions to the NPS account are eligible for tax deductions of up to Rs. 2,00,000 – under Section 80CCD (1), they are eligible for deductions up to Rs. 1,50,000 while Section 80CCD (1B) allows an additional deduction of up to Rs. 50,000.

Moreover, upon retirement, you can withdraw up to 60% of the corpus as a lump sum tax free and the remaining 40% can be used to purchase the annuities. An annuity is a product that will provide you with a pension at a fixed rate. You can purchase the annuity by paying a lump sum amount. However, the income from annuities are taxable. With ELSS investments, if you opt for the old tax regime, you are eligible for tax deductions up to Rs. 1,50,000 per annum under section 80C of the Income Tax Act, 1961. It means you can save up to Rs. 46,800/- if you fall under the highest tax bracket of 30%. Any gains earned on ELSS investments are subject to capital gains tax.

Which is Better for Tax Saving?

When looking at it from a pure tax savings point of view, NPS seems like a better investment avenue given that you can claim deductions of up to Rs. 2,00,000. In comparison, ELSS allows for deductions of only up to Rs. 1,50,000. However, when choosing between the two investments, you may want to consider the other aspects.

For instance, NPS is suited to long-term investment objectives since it has a more extended lock-in period, and withdrawals are also limited whereas ELSS has a shorter lock-in period of just three years. With NPS you can choose to allocate your assets in various funds, i.e., a combination of equity and debt in your portfolio, while ELSS invests only in equity instruments.

 

Conclusion

Both NPS and ELSS are good options when it comes to tax savings. While NPS provides a higher tax deduction benefit than ELSS, the investment objectives for both vary. You need to consider your investment horizon, investment objective and risk profile when making an investment decision in either of these instruments.

 

Disclaimer – ICICI Securities Ltd. ( I-Sec). Registered office of I-Sec is at ICICI Securities Ltd. - ICICI Venture House, Appasaheb Marathe Marg, Prabhadevi, Mumbai - 400 025, India, Tel No : 022 - 6807 7100.  AMFI Regn. No.: ARN-0845. PFRDA registration numbers:  POP no -05092018. We are distributors for Mutual funds and National Pension Scheme (NPS). Mutual Fund Investments are subject to market risks, read all scheme related documents carefully. Please note, Mutual Fund and NPS related services are not Exchange traded products and I-Sec is just acting as distributor to solicit these products. All disputes with respect to the distribution activity, would not have access to Exchange investor redressal forum or Arbitration mechanism. The contents herein above shall not be considered as an invitation or persuasion to trade or invest.  I-Sec and affiliates accept no liabilities for any loss or damage of any kind arising out of any actions taken in reliance thereon. Investments in securities market are subject to market risks, read all the related documents carefully before investing. The contents herein mentioned are solely for informational and educational purpose.

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