The Income Tax Act, 1961 makes every income-earning citizen liable to pay taxes on it. Parting away from your hard-earned money can be tough, but paying taxes is mandatory, and as responsible citizens, we must pay our taxes.
Personal income tax planning is an important aspect of paying taxes, but most taxpayers don’t pay attention to it unless the accounts department in their office reminds them to submit their tax-saving investment proof in December. Sometimes, they also resort to tax planners and insurance agents at the last moment to gather their proofs.
Commonly, people are unaware of the tax planning process and also make no attempts to understand them. As a result, they end up investing their money in schemes that are not aligned with their long-term financial goals. Therefore, tax planning is always critical to one’s proper financial plan.
Talking of the most popular long-term investment schemes in our country, Equity Linked Savings Scheme (ELSS), Public Provident Funds (PPFs), and National Pension System (NPS) have stayed at the top of their games. While PPFs began circulating as early as 1968, NPS didn’t come into existence until January 2004. However, going for an Equity Linked Saving Scheme (ELSS) brings a better opportunity for young investors to generate excellent long-term returns with a fair bit of risk.
All of the investment schemes are designed to help taxpayers build their retirement corpus. But how does each of them compare against each other? Let’s take a look at each of them and understand how they can contribute to your long-term financial goals.
ELSS funds for tax saving
ELSS is an excellent investment tool for people with higher risk appetite. They are diversified equity funds that come with a lock-in period of three years and offer the benefits of tax-savings, capital appreciation, and tax-free returns.
A tax of 10% is levied on long-term capital gains from ELSS if it’s above Rs. 1 lakh. It’s a known fact that equities offer a higher chance of better returns as compared to any other asset class over a long period, but, as ELSS investments are linked to the market, volatility and risks are involved.
Public Provident Fund
For investors who are reluctant to take risks, the public provident fund works as one of the best options for them to save taxes. It also helps them to reap the benefits of risk-free and tax-free returns. At a maximum, a single investor is allowed to deposit Rs. 1.5 lakhs in his/ her PPF account per annum. This helps individuals in the highest tax bracket save taxes up to Rs. 45,000 per year. The PPF has also been linked with the 10-year government bond yield.
NPS
The NPS was introduced as a Government Scheme with the major aim to instill pension reforms and inculcate saving habits among individuals. People can invest during their earning years so that they can receive a pension upon retirement. The investments made in NPS are exempted for a tax deduction of up to Rs. 1.5 lakh under Section 80C of the Income Tax Act. Besides, the investors also qualify for an additional deduction of Rs. 50,000 under the rules of Section 80CCD (1B) of the said Act.
There are three broad categories of equity in which the NPS funds are invested – Nifty stocks, government securities, and corporate debts. In equities, all funds to a great extent have managed to deliver 50-100 basis points, which are more than Nifty and less than ELSS over a period of one, three, and five years. The corporate debt returns have been running at a rate of 1.7 to 3.5 percentage points more than debt mutual funds over time.
The age limit for individuals to enter into NPS is 65 years. A Permanent Retirement Account Number or PRAN is allotted to the NPS subscriber through which he/she can access two personal accounts – Tier I and Tier II.
- Tier I account: People holding a Tier I account cannot withdraw any amount until they are 60 years of age. But in case the account is active for at least three years, the account holder is allowed to partially withdraw from the account only for special reasons like children’s marriage or higher education, or for treatment of illnesses such as cancer or organ transplant.
However, an NPS subscriber has the allowance to withdraw up to 25% of the contributions made. Here, it’s important to note that all the tax benefits associated with NPS are possible with only the Tier I account. While you can deposit Rs. 1,000 in a financial year to keep the NPS Tier I account, you also need to maintain a minimum balance of Rs. 2,000 in the account.
- Tier-II account: The Tier II account is a basic voluntary savings facility which allows the subscriber to withdraw from the account without any limitations. But this doesn’t come with any tax benefits.
One benefit that the Tier II account offers is the low fund management charges at the rate of 0.1% of the invested amount. The subscriber is free from paying any minimum annual amount as well as maintaining a minimum balance in the account.
Tax Treatment
The tax treatment of the amount put in Tier I account fall under the EET (Exempted-Exempted-Taxed) category. A minimum of 10% of the total gross income or salary (including the basic and dearness allowance) is applicable for tax deduction according to Section 80CCD (1A).
Additionally, a tax benefit of Rs. 50, 000 can be allowed on the NPS investments under Section 80CCD (1B). The accrued gains on investments made and the amount paid for buying the annuity are exempted from tax. However, the EET regime allows a tax exemption on 40% of the total amount payable, applicable for both salaried individuals and business people, during the time of closure or opting out. The rest 60% of the accumulated amounts are taxable though.
Besides, depending on the age at which the subscriber is opting out, it’s mandatory for them to use 40% or 80% of their total corpus to buy an annuity. Returns from the annuity are taxable as Income from Other Sources.
PPF Vs. ELSS
PPF and ELSS do not have a fair comparison to start with. PPF forms the debt component of your portfolio, and unlike ELSS and NPS doesn’t give any exposure to equity. Let’s say you have invested an amount of Rs. 50,000 in an ELSS fund and PPF for 15 years on a yearly basis. If you compare the returns at the end of the tenure, your maturity amount will be around Rs. 14 lakhs going by the interest rate of 7.9%.
However, investing the same amount as a yearly investment in some top ELSS funds will bring your corpus to around Rs. 28 lakhs.
ELSS Vs. NPS
The above paragraph describes how debt-oriented PPF compare against equity-oriented ELSS. Let’s see how ELSS and NPS differ from each other and which one is better based on the following points.
- Taxation – Considering the returns that these tax saving instruments can bring, ELSS is better. Moreover, it also offers the shortest lock-in period of just three years. NPS, on the other hand, if tax-free for only up to 40% of the total corpus accumulated. You still have to pay taxes on the rest of 60%.
- Annuity – As mentioned earlier, it’s compulsory to put 40% of your funds in an annuity in case of NPS. However, that’s not the case with ELSS, where you are free to access your money after the 3 years tenure.
- Equity Exposure – As the name suggests, ELSS is equity-based. But in NPS, you are allowed for a maximum of 50% in equity funds. So people with higher risk appetites will miss out on an opportunity if they go with only NPS.
- Returns – As equities offer better returns than other asset classes, the returns in ELSS will obviously be higher than NPS, which has a cap limit on exposure to equity.
- Liquidity – With NPS, the tier I investor is allowed to withdraw 20% of his corpus before he/she is 60 years of age, but that is possible with certain conditions. You should have invested in it for at least a period of ten years, and after that, you can make a total of three withdrawals subject to a gap of five years between each withdrawal.
ELSS has a lock-in period, but you just have to wait for three years to get access to your money.
Finally, what matters is a substantial retirement corpus. ELSS sure gives you the option of liquidity in 3 years, but that also depletes your retirement corpus. Therefore, it’s recommended to stay invested for a long period and make good use of these tax-saving instruments to reach your financial goals.
Which one should you take?
First of all, you need to be clear about your long-term goals and risk appetite. Which investment instrument you go for will be based on that. Secondly, there are two more factors that you have to consider – the financial situation and age.
Investors who can manage the risks involved in equity can opt for ELSS or NPS. For others, PPF is a good option. Generally, young investors are recommended to choose ELSS funds because they can deal with the risks and market volatilities and earn high returns.
As you have to invest a minimum of 40% to buy an annuity or pension, you can directly invest in annuities instead of subscribing to the NPS if you have enough money.
Suppose, you have a period of 15-20 years at hand until you retire, and don’t have a PPF account yet. In that case, it’s better to create one now and start depositing regularly.
Conclusion
The key to successful tax-saving lies in making smart combination in ELSS and PPF by investment experts. With a good asset allocation with PPF, invest in an ELSS scheme of your choice as well. Eventually, you can see financial growth and substantial wealth over a long period.
Author Bio:
Ankur founded Goalwise a direct mutual fund investment app in 2015 to serve as a ‘Fitbit to investing’. A passionate Algo-investor, he honed his skills as a Researcher and Portfolio Manager at leading hedge funds such as Oxus investments. He is an alumnus of IIT Kanpur where he pursued Computer Science and Engineering.
