ELSS vs NPS – Comparison between ELSS & National Pension Scheme

Saving taxes is something that everyone would like to do. There are many investment schemes like Equity-Linked Saving Scheme, National Pension Scheme, Tax saving FDs, NSC, and PPF, which offer tax benefits under Section 80C. In this article, we have compared ELSS with NPS.

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Equity Linked Savings Scheme (ELSS)

Equity-Linked Saving Scheme (ELSS), popularly known as ELSS, is a tax saving mutual fund where one can save up to Rs 1,50,000 in a financial year under Section 80C. It has a lock-in period of just three years, the shortest among all tax-saving investment options. Long-term capital gains of over Rs 1 lakh being taxed at the rate of 10%.

National Pension Scheme (NPS)

National Pension Scheme (NPS) is a government-backed scheme in which individuals invest during their earning years to get a pension upon retirement. Investments in NPS offers a tax deduction of Rs 1,50,000 under Section 80C of the Income Tax Act and an additional deduction of Rs 50,000 under Section 80CCD (1B) of the Income Tax Act.

What are the Key Features of NPS

Structure:

NPS are divided into two types of accounts

Tier I (mandatory with a lock-in period until retirement)

Tier II (voluntary with no lock-in period).

Tax Benefits:

Investments made in NPS up to Rs. 1.5 lakh qualify for tax deductions under Section 80C, with an additional deduction of Rs. 50,000 available under Section 80CCD(1B).

Withdrawal Rules:

At the time of retirement, up to 60% of the corpus can be withdrawn tax-free, while the remaining 40% must be invested in an annuity for a pension income.

Returns:

NPS generates Moderate and stable returns over the period, averaging around 8-10% annually over the past decade.

What are the Key Features of ELSS

Structure:

ELSSS is an Open-ended mutual fund scheme in two different types of GROWTH and ICDW plans with a compulsory lock-in period of three years.

Tax Benefits:

Investments made in ELSS in a financial year are up to Rs.1.5 lakh qualify for tax deductions under Section 80C.

Withdrawal Rules:

You can withdraw the entire investment amount after the three-year lock-in period, offering higher liquidity compared to the withdrawal process of NPS.

Returns:

ELSS has delivered historically higher than NPS, averaging 12-15% annually in top-performing funds.

Difference Between NPS and ELSS

NPS and ELSS share similar investment methods. Both instruments pool money from investors and allocate it across various assets on their behalf, whereas ELSS are managed by professional fund managers who actively oversee portfolios to generate favourable long-term returns.

However, there are key differences between them

Investment Type

NPS invests in a diversified mix of asset classes, including equities, government bonds, corporate bonds, and other securities, to provide the benefits of a well-balanced portfolio.

ELSS primarily invests in stocks, equities, or equity-linked instruments, which carry higher risks but also offer the potential for higher returns.

Lock-in Period

The National Pension System has a longer lock-in period, extending until the individual's retirement age, promoting a disciplined approach to building a stable long-term corpus.

ELSS, on the other hand, has a lock-in period of just three years, providing investors with the flexibility to address short- or medium-term financial goals.

Risk and Returns

NPS diversifies the investment across multiple asset classes, it carries lower risk and provides more stability, but it tends to offer moderate returns over time.

ELSS, being equity-focused, which carries higher risk but has the potential for higher returns, helping investors build greater wealth over time.

Tax Benefits

Both schemes offer tax benefits under Section 80C of the Income Tax Act, helping investors reduce their taxable income.

For NPS, upon maturity at retirement, 60% of the corpus can be withdrawn tax-free, while the remaining 40% must be used to purchase an annuity.

In the case of ELSS, after the three-year lock-in period, withdrawals are tax-free up to a specified limit.

Withdrawals

Withdrawals from NPS are allowed only partially after a certain lock-in period, ensuring that a portion of the corpus remains secured for retirement through an annuity plan.

ELSS funds, however, are fully accessible once the three-year lock-in period is over.

Control and Flexibility

NPS has stricter withdrawal rules and mandates the purchase of an annuity upon retirement, emphasizing long-term capital preservation.

ELSS, in contrast, offers greater flexibility, allowing investors to choose fund options that align with their financial goals and risk appetite.

Comparative Analysis between ELSS and NPS

NPS vs ELSS Which One Should I Choose?

Always the right choice between NPS and ELSS depends on your financial goals, risk appetite, and your investment horizon.

You can choose NPS if you want a disciplined, long-term investment plan for retirement with stable returns and lower risk. NPS is ideal for individuals looking to build a secure pension corpus.

ELSS is a great option for those looking for tax savings with greater liquidity and market-linked growth potential, are comfortable with higher risk and want to maximize returns in a shorter period.

Conclusion

Even though NPS offers tax benefits of up to Rs 2 lakh a year, as opposed to the ELSS tax benefits of up to Rs 1.5 lakh, ELSS is still the better investment option. The latter provides flexibility and the opportunity to earn higher returns with a lock-in period of only three years.