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NPS vs ELSS: Which One is Better for Tax Saving?

  • Akarshita Yaji
  • Oct 03 2021
  • 6 minutes
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Your retirement kitty is a product of a lot of planning and deliberation. However, are there still some investment choices that you have not made up your mind about? For instance, is NPS better than ELSS? Or is the latter a better mode of investment than the former? On what basis should you pick one over the other? Should you invest in both? Read on to find your answers.

What is NPS?

  • National Pension Scheme (NPS) is a social security measure and a government retirement scheme that is meant to develop a sizable corpus for retirement of government employees (originally) and now for employees of the unorganized worker and private sector employees. 
  • NPS allows for flexibility in investment as one can increase or decrease his or her contribution on an annual basis.
  • The equity exposure is limited to 50 to 75% for these schemes and hence, they come with lower risk. But this also means that the returns are sizeably lesser. 

What is ELSS?

  • Equity Linked Savings Scheme known as diversified equity funds and these offer the investor tax benefits that are applicable under the income Tax Act.
  • ELSS have at least 80% of the total assets invested in equity and equity related instruments for a 3-year lock-in period.
  • The power of compounding is what makes these ELSS funds a lucrative option for investors and the high returns helps beat inflation over the long run. 
  • However, the performance of the ELSS is based on the risk exposure to the market.

What are the similarities between ELSS and NPS?

Like any other investments there are a lot of similarities between ELSS and NPS, let’s take a look at them.

  • Both instil financial discipline in the investors.
  • Both the investment options pool in money from the investors and channelize the same into different asset classes.
  • Contributions made into the corpus are voluntary.
  • There is limited flexibility in the withdrawal of the funds.
  • Both the investment options are professionally managed.
  • Both of these funds are eligible for tax deductions under Section 80C of the Income Tax Act.

What are the differences between the NPS & ELSS?

Basis ELSS NPS
Meaning  ELSS funds are diversified equity funds with a three year lock-in period. It is a government retirement scheme meant to develop a sizable corpus for retirement.
Equity exposure The equity exposure can go up to 100%. The equity exposure is merely 50 to 75%.
Risk  The risk depends on market fluctuations.  Lower risk as the equity exposure is capped at a level. Also it is government backed.
Asset class Investors allocate into equity Investors allocate funds into 4 asset classes namely, Equity, Corporate Debts, Government Bonds and Annuity.
Fund manager You can choose between ELSS funds from different AMCs Can change fund manager every financial year.
Historical performance of returns Historical returns in the range of 12+% Delivered approximately 8 to 10% returns on average annually.
Lock in period It is for 3 years. Usually till retirement. 
Premature withdrawal  It cannot be prematurely withdrawn. It can be prematurely withdrawn but within certain limits.
Minimum contribution  Minimum is Rs. 500 or even Rs 100 in some funds. There is no maximum.  Minimum is Rs. 1000. There is no maximum.
Tax benefit The contribution is exempt from tax up to Rs 1.5 lakh. On redemption, Capital Gains tax may be payable The entire amount is tax-free i.e. EEE. But the annuity that you get from NPS is subject to tax.

Which option offers more benefits?

  • Despite the tax benefits that NPS has to offer, equity mutual funds especially, the tax-saving ELSS awards the investor a lot more flexibility in terms of choosing options, schemes and investment time horizon – something that can help one build the retirement corpus that suits their requirements the best.
  • NPS does not give the option to invest in long term equity assets like ELSS does as there is a mandatory requirement for fixed income exposure. Therefore, over long periods of 10 to 20 years, equity assets, which deliver efficient inflation cover and growth, cannot be harnessed in NPS like in the ELSS scheme.

Which option is more suitable for Tax Saving?

If we were to solely look into the tax treatment of both these investment options, then the following would present itself before us – 

Feature NPS ELSS
Tax deduction on the amount invested  For NPS sums up to Rs. 1,50,000 is exempt under section 80C and a further Rs. 50,000 is exempt under Section 80CCD(1B). For ELSS sums up to Rs. 1,50,000 are exempt under Section 80C.
Tax on maturity amount The maturity amount is partially taxable on 60% withdrawal amount. It is fully taxable on the annuity pension income. The maturity amount is taxable under capital gains tax. The long-term capital gains are zero up to Rs. 1,00,000. Long Term Capital Gains tax to be taxed at 10% without indexation benefits for amounts exceeding Rs. 1,00,000.

Both the investment options are great choices if the main goal is to save on taxes. NPS has a slight edge over ELSS funds in this area particularly as it falls under the EEE category and no capital gains tax has to be paid by the investor on the NPS amount.

Experts believe that if a proper decision regarding this dilemma is to be arrived at then one has to deliberate and weigh the following considerations – probable age of retirement, the amount of corpus that needs to be accumulated, the investment horizon and the risk profile of the investor.

FAQs

  1. Is an NRI eligible to join NPS?
    Yes, an NRI is eligible, subject to him or her retaining his or her indian citizenship status. The minute the NRI loses his or her citizenship in India, he or she can no longer enroll in this scheme.
  1. What are POPs in NPS?
    POPs are Points of Presence i.e. entities that help a citizen navigate through the NPS architecture. Details regarding your closest POP can be traced with the help of POP SP (nsdl.co.in).
  1. Who manages the funds in NPS?
    PFRDA registered fund managers are responsible for the management of the monies invested. There are 8 fund managers as on date.
  1. What is the maximum sum that a self-employed person can contribute to NPS to avail the benefit under Section 80CCD (1)?
    A self-employed person can contribute 10% of his or her gross income as per Section 80CCD (1) into the NPS scheme.
  1. Are the redemption proceeds in ELSS tax Free?
    No, this is not true. Long Term Capital Gains of up to Rs. 1,00,000 is tax free, but any amounts above the same are subject to a tax of 10% and cesses and surcharges.

 

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