ELSS or NPS: Which is Better for Tax Benefits?

Securing tax benefits is a significant consideration for many investors in their financial planning. Among various investment options available in India, the Equity Linked Savings Scheme (ELSS) and the National Pension System (NPS) are known for their tax-saving potential.

Each of these schemes has its unique advantages and caters to different investor needs. This blog explores the details of ELSS and NPS, comparing their tax benefits to help you make an informed decision.

What is ELSS?

ELSS is a type of mutual fund that primarily invests in equities. It has a mandatory lock-in period of three years, the shortest among tax-saving instruments under Section 80C of the Income Tax Act. The dual benefit of potential high returns and tax savings makes ELSS a popular choice among investors.

What is NPS?

NPS is a government-backed retirement savings scheme that aims to provide a regular income post-retirement. It offers a diversified portfolio with exposure to equities, government bonds, and corporate debt. Investors can also contribute to tax saving in NPS.

Tax Benefits: A Comparative Analysis

ELSS For Tax Saving

1. Section 80C: Investments in ELSS qualify for tax deductions under Section 80C, up to a limit of ₹1.5 lakh per financial year.
2. Long-Term Capital Gains (LTCG) Tax: Gains from ELSS are subject to LTCG tax. Gains up to ₹1 lakh in a financial year are tax-free, while gains exceeding this limit are taxed at 10% without the benefit of indexation.

With a shorter lock-in period of just 3 years, ELSS provides more flexibility compared to the NPS tax saving scheme. As an equity-linked investment, ELSS has the potential to deliver high returns, but it also comes with a higher level of risk. However, its tax benefits are restricted to just Section 80C.

NPS For Tax Savings

1. Section 80C: Contributions to NPS are eligible for tax deductions under Section 80C, up to ₹1.5 lakh per financial year.
2. Section 80CCD(1B): An additional deduction of ₹50,000 per financial year is available for contributions to NPS under Section 80CCD(1B).
3. Employer Contribution: If the employer contributes to your NPS account, this contribution is deductible up to 10% of your salary (basic + DA) under Section 80CCD(2). This deduction is over and above the limits of Section 80C and Section 80CCD(1B).
4. Tax on Withdrawals: On retirement, up to 60% of the accumulated corpus can be withdrawn tax-free. The remaining 40% must be used to purchase an annuity, which is taxable as per the individual’s slab rates upon receipt.

NPS tax saving scheme is a long-term savings solution until age 60 and is less liquid than ELSS. However, NPS offers a lower risk profile, making it a more stable option. Additionally, investments in NPS are eligible for additional tax benefits under Section 80CCD(1B) and Section 80CCD(2).

Conclusion

Both ELSS and NPS tax saving schemes offer compelling tax benefits, but they serve different financial goals and investor profiles. ELSS is ideal for those seeking short-term tax savings with the potential for higher returns, suitable for investors with a higher risk appetite. On the other hand, NPS is tailored for individuals focusing on long-term retirement planning, offering a balanced investment approach with substantial tax benefits. Choosing between ELSS and NPS depends on your financial objectives, risk tolerance, and investment horizon.