The government of India allows you to lower your tax liability if you invest in schemes mentioned under Section 80C. Some of these include investment options like Equity Linked Savings Scheme, National Pension Scheme, PPF, Tax saving FD, NSC etc. These schemes differ in terms of the risks associated, the interest rate offered, lock-in periods and investment objectives, catering to a wide range of investors. Under Section 80C, you can invest in the aforementioned schemes and get tax relief up to Rs 1.5 Lakhs. Ideally, you should make tax planning an integral part of your financial planning and begin investing in tax saving avenues as soon as the financial year begins. However, if you haven’t yet started investing to save taxes, you only have a little time left till the financial year ends to make a move. To help you make a decision fast, I will compare two popular tax saving options.
In this article
Equity Linked Savings Scheme ( ELSS)
Equity-linked savings scheme is a type of equity mutual fund that comes with the double benefit of tax saving and wealth creation. These are managed by professionals and experts and hence result in greater returns as compared to other tax-saving investments.
Taxpayers can benefit from up to Rs. 1.5 lakh per year by investing in ELSS funds. Although you can invest more than Rs. 1.5 lakh in ELSS funds but only Rs. 1.5 lakh will be allowed for tax benefits. However, the returns generated from ELSS fund investments are taxable in nature. The taxes
applicable to these are DDT and LTCG i.e. Dividend Distribution Tax and Long-Term Capital Gain Tax. Nonetheless, ELSS has succeeded in grabbing the highest attention when it comes to tax-saving investment options.
ELSS comes with a lock-in period of three years, the lowest lock-in among other tax saving investment option and investors can invest in ELSS via the SIP route or the lump-sum route.
National Pension Scheme ( NPS)
National pension scheme is a government-backed pension scheme offered to employees and self -employed individuals to invest in for retirement. The pension scheme allows a tax deduction of Rs 1.5 Lakh under Section 80 C and an additional deduction of Rs 50,000 under Section 80 CCD ( 1B) of the Income Tax Act. Now that we know the basics of these schemes, let’s compare them on various parameters:-
Asset Allocation and Returns
For NPS investors there are two options when it comes to allocating their investments across asset class; Active Choice and Auto Choice. Please note, subscribers can go for a single asset class or multiple asset classes as per risk profile, however, the maximum asset that can be allocated to equity is up to 75% of the total portfolio till the subscriber reaches 60 years of age. Thereafter, the permissible equity allocation will reduce by 2.5% per year, reaching the 50% mark by the time the subscriber attains 60 years of age. This portfolio rebalancing is to ensure the subscriber is not exposed to high risk when the maturity period nears.
Subscribers lacking the required knowledge and skills for managing their asset allocation can opt for Auto Choice, which comes with a pre-defined proportion of different asset classes based on the age of the subscriber. Subscribers have three types of Lifecycle Funds to choose from — Aggressive Life Cycle Fund, Moderate Life Cycle Fund and Conservative Life Cycle Fund — with maximum equity exposure cap of 75%, 50% and 25%, respectively, till the age of 35 years. Thereafter, the equity proportion will steadily reduce with the increasing age as per the pre-set asset allocation.
In the case of equity mutual funds, at least 65% of the funds’ portfolio has to be invested in equities. ELSS, popularly known as tax-saving mutual funds, ‘large and mid-cap funds’ and large-cap funds have to hold at least 80%, 70% and 80% of their corpus in equity and equity-related instruments. As equity as an asset class beats other asset classes by a wide margin over the long term, the higher exposure to equities through equity mutual funds will allow mutual fund retirement portfolio to outperform the National Pension System in wealth generation over the long term. Those lacking the skills for managing their own asset allocation can invest in aggressive hybrid funds, balanced advantage funds and multi-asset allocation funds, which dynamically increase or decrease exposure to equities and other asset classes depending on the changing market conditions.
Taxation of withdrawals/maturity
Currently, at least 40% of the NPS corpus on maturity has to be used for purchasing annuities and the rest can be withdrawn lump sum. Part of the corpus used for purchasing annuities is tax-free although the interest income derived from it is not. The Budget 2019 has made the lump sum withdrawal of the rest of the NPS maturity corpus fully tax-exempt, bringing in tax parity with other retirement solutions, such as PPF and EPF.
Equity mutual funds are slightly at a disadvantage as far as the taxation of the investment corpus is concerned. Gains made on redeeming equity mutual funds are subject to LTCG taxation @ 10%. However, this taxation will only apply to gains exceeding Rs 1 lakh in a financial year. Moreover, the outperformance of equity mutual fund over NPS in terms of wealth creation might neutralise the NPS edge in tax savings.
Lack of liquidity is a major drawback of the NPS scheme. Premature withdrawal is allowed only after 10 years whereas partial withdrawals are allowed after 3 years for just 25% of the investor’s contribution. Moreover, partial withdrawal is allowed for only three times during the entire subscription period for specified reasons — purchase/construction of the residential house, children’s higher education and marriage, and treatment of critical illness. In case of premature exit, at least 80% of the accumulated NPS corpus has to be used for purchasing annuities and the rest can be withdrawn lumpsum. The subscriber can opt for 100% lumpsum withdrawal only if the accumulated corpus is not greater than Rs 1 lakh. However, there are no restrictions on redemption or closure of Tier II NPS account.
Equity mutual funds, except the close-ended funds, do not have any restrictions on withdrawals apart from the lock-in period of 3 years in ELSS. Investors are free to invest and redeem their equity mutual fund schemes based on the changes in the market conditions, risk appetite and their own fund requirements. Thus, retirement portfolio consisting of equity mutual funds outscore NPS in terms of liquidity.
Under the NPS scheme, mandatory investment of at least 40% of the accumulated corpus in annuities is aimed at providing stable post-retirement income to their subscribers. However, returns generated from annuities are very low and may not beat inflation rates. Moreover, interest earned from annuities is taxable too. The rising life expectancy along with inflation rates may render the pension income insufficient.
A retirement portfolio consisting of equities might be better suited to deal with the post-retirement expenses. Once an investor nears the retirement age, say 2-3 years away from his retirement, he can initiate the Systematic Transfer Plan (STP) in his equity funds to steadily redeem pre-determined amount each month from his equity funds for investment in short-term debts funds. Short-term debt funds have a very low risk of capital erosion but still generate higher returns than bank fixed deposits. Once the retirement life sets in, the investor can initiate Systematic (SWP) in those debt funds to derive monthly cashflows for meeting his daily expenses. While setting the STP, the investor should try to remain invested in equities for at least 15 years after his retirement age. This will allow him to continue to benefit from the higher upside potential of equities while beating the twin challenges of inflation and increased life expectancy
Comparative Analysis Between ELSS and NPS
|Lock In Period||ELSS has a three year lock-in period||Lock-in upto 60 years|
|Minimum Annual Investment Amount||Rs 500, SIP or Lumpsum route||Rs 500 as initial contribution every year|
|Tax benefits||1.5 LPA deduction can be claimed as exemption U/S 80C||1.5 LPA deduction can be claimed as exemption U/S 80C . Additionally. Rs 50,000 can be claimed as tax relief U/S Section 80 CCD (1B)
Section 80CCD (2) : 10% of basic
|Asset Allocation||Equity||A maximum of 50% in equity rest in government securities|
|Premature Withdrawals||Cannot withdraw before lock-in||Can be withdrawn under certain limits on condition of purchasing an equity.|
|Taxability of returns||LTCG over 1 Lakh, taxed at 10%||Maturity corpus is partially taxable.|
Tax planning is an essential part of financial planning and its essential to select an avenue that suits your risk profile and liquidity needs. Carefully weigh the pros and cons and take a call accordingly.
Disclaimer: The views expressed in this post are that of the author and not those of Groww