Which is the best tax saving option between PPF, NPS and ELSS?
Most people wake up to tax planning, only when the accounts department in their office rings the alarm bell in December, to submit tax saving investment proof. A few frantic phone calls and visits to tax planners, postal/ insurance agents later, the pressing need for investments and the proof thereof is met. Most people make no attempt to understand the process of tax planning thoroughly. As a result, they often end up parking their money in schemes that do not usually serve their long-term financial goals. Saving taxes becomes the sole objective, at that point in time. This, despite the fact that tax planning should always be incidental to one’s financial planning. Let us have a detailed look at some of the popular tax saving options.
Public Provident Funds (PPFs) and the National Pension System (NPS) along with Equity Linked Savings Scheme (ELSS) have been the most popular long-term investment schemes in our country.Compared to PPFs that have been in circulation since 1968, NPS is a much later entrant, introduced only in Jan 2004. However, to a rising number of young investors who are open to a fair bit of risk, Equity Linked Savings Schemes (ELSS) offered by mutual fund houses, have emerged as a worthy opportunity to generate attractive long-term returns, when invested for a longer period. All of them have been designed in a way to build one’s retirement corpus.
But how do the three schemes stack up against each other? Let’s have a look at each of them and find out what they have for us:
PPF is one of the best tax saving option for the risk-averse investor. It offers triple benefits of tax saving, risk-free and tax-free returns. A single investor can deposit a maximum of Rs. 1.5 lakhs per annum in his/her PPF account. Leading to a yearly tax saving of around 45,000/- to those who are in the highest tax bracket.
However, it’s been almost 4 years now that the government decided to link PPF with the 10-year government bond yield. In our country, the interest rates have been high for quite some time now and the same is expected to soften from this year. While benign interest rates are undeniably good news for equity investors, we may witness lower PPF rates in the coming years because they are linked with the 10-year bonds.
Following is how the PPF interest rates have changed over the years:
What about NPS?
The NPS was introduced to extend retirement income to all citizens and aims to still pension reforms, besides inculcating the habit of savings. Investors in NPS qualify for an additional deduction of Rs. 50,000 under section 80CCD (1B) of Income Tax rules.
The maximum age of entry to NPS is 65 years.An NPS subscriber is allotted a Permanent Retirement Account Number (PRAN), which provides access to two personal accounts listed below:
Tier I account: It’s a non-withdrawable account till the person reaches the age of 60 years. However, if the account is active for minimum 3 years, partial withdrawal is allowed in specific cases such as children’s higher education, children’s marriage, treatment of illnesses like cancer, renal failures, organ transplant etc.
However, an NPS subscriber can withdraw up to 25% of the contributions made. All tax benefits associated with NPS are linked to Tier 1 account only.
The minimum amount that can be deposited in a financial year to keep the NPS Tier I account isRs.1,000. Also, the minimum balance to be maintained in the account isRs.2,000.
Tier II account: This is a simple voluntary savings facility. The subscriber can freely withdraw from the account. But no tax benefit is available.
The advantage of Tier 2 account is low fund management charges at that rate of 0.1% of the invested
There is no minimum annual contribution required nor there is a need to maintain a minimum balance in a Tier 2 account.
Tax Treatment of NPS
Tax treatments for Tier I contributions are currently considered under Exempted-Exempted-Taxed (EET). Tax deduction of Rs. 1,50,000 under section 80CCD (1A) is allowed.
However, due to the EET regime, the accumulated amount at the time of closure or opting out, 60% of the total amount payable is exempt from tax for employees as well as business people. The remaining 40% of the accumulated amount is taxable.
Also, depending on the age of exit, 40% or 80% of the total corpus has to be compulsorily used to buy an annuity. The annuity payments received is taxable as Income from Other Sources.
NPS funds are invested in three broad equity categories (mostly Nifty stocks), government securities and corporate debts. In equities, all funds have largely managed to deliver 50-100 basis points more than Nifty over one, three, and five-year periods, which is much lesser when compared to ELSS.
Corporate debt returns have been ranging between 1.7-3.5 percentage points more than debt mutual funds over time.
Let’s have a look at the returns generated by NPS Tier- I account under various schemes:
Comparison of NPS returns since inception
ELSS as a tax saving option
For those who can take risks, ELSS is a popular tax saving option under section 80C. An ELSS gives triple benefits of capital appreciation, tax savings and tax-free returns. ELSS are diversified equity funds having three-year lock-in tenure from the date of investment.
The dividends are tax-free at the hands of the investor. Long-term capital gains of above Rs.1 lakh from ELSS is subject to tax at the rate of 10% of the gains made. Equities, over a longer period of time, give higher returns against any other asset class. But since ELSS investments are linked to the market, they are subject to volatility and risks.
PPF vs ELSS
In a strict sense, it won’t be fair to compare PPF and ELSS as both ELSS and NPS, gives exposure to equity whereas PPF forms the debt component of your portfolio. However, let’s just have a look at a comparison of returns for Rs. 50,000 invested in an ELSS fund and PPF over a period of 13 years.
If you had invested Rs. 50,000 annually in your PPF in 2001, the PPF corpus as on 1st September 2014, was Rs. 11.4 lakhs, along with the cumulative investment of Rs. 6.5 lakhs over a period of 13 years.
The chart below reveals PPF returns during the investment tenure:
The chart below reveals the ELSS returns during the investment tenure:
ELSS vs NPS
In the paragraph above, we have compared a debt-oriented instrument with an equity-oriented instrument. Let’s just also compare two instruments that give us exposure to equity funds and see which one is better among the two based on the points below:
1. Taxation: Currently ELSS is the best tax saving instrument among all which offers better returns over the long term and comes with the shortest lock-in period i.e. 3 years. On the other hand, NPS on maturity is tax-free up to 40% of the total corpus accumulated and the remaining 60% is taxable.
2. Annuity: As stated above, in NPS you have to put at least 40% of your funds in an annuity which is not the case in ELSS, which means you have access to your money once the lock-in period gets over if you choose to go with ELSS.
3. Equity Exposure: Equity Linked Savings Scheme (ELSS), the name itself suggests everything. On the other hand, in NPS there is a cap of maximum 50% in equity funds. People who want to take higher risk will certainly lose out on an opportunity if they choose to go with NPS.
4. Returns: As ELSS is a purely equity-based scheme so the returns will be higher as compared to NPS, which has an upper cap on equity exposure.
5. Liquidity: Tier 1 investors can only withdraw 20% of the corpus before reaching 60 in case of NPS. However, to attain this, you should have made contributions for a minimum of 10 years and only 3 withdrawals are allowed which is further subject to a gap of 5 years between each withdrawal. On the other hand, even though you cannot withdraw money before the maturity in ELSS, you will have access to your money in just 3 years.
However, despite ELSS giving you the option of liquidity in just 3 years, withdrawing money would result in the depletion of your retirement corpus. Hence, it’s advisable to stay invested for a longer duration as these instruments are designed to build your retirement corpus. That means the longer you stay invested, the larger will be your retirement corpus.
So which of the three?
Your investment choice must be guided by your long-term objectives and your risk appetite. The latter is based on many factors. Financial situation and age are the two most important determinants.
Investors ready to take the risk of investing in equity have the option to go with ELSS or NPS. Others should invest in PPF. Wealth creation, over a period of time, is much higher with ELSS.
ELSS is ideal for young investors. They usually have the high-risk appetite and enough time to tide over market volatilities.
NPS subscribers, at the time of withdrawal of the corpus, have to invest at least 40% of it to buy an annuity (pension) scheme from designated annuity providers. But anyone having enough money can invest in annuities. There’s no need to subscribe to the NPS. In a sense, it’s the annuity providing the pension and not the NPS.
If you have no PPF account and are about to retire in 15 or 20 years time, you must open one and start depositing regularly. This will help you to build a corpus by your retirement time. Your risk tolerance reduces as you close in on retirement and PPF is a good bet under such circumstances.
It’s mandatory for salaried people to contribute a part of their salary to the Employee Provident Fund (EPF). EPF contribution of the employee which goes towards 80C tax savings can be replaced by ELSS if you are not nearing retirement. ELSS, via the systematic investment plan (SIP) for a long-term horizon, will help in both tax and retirement planning.
So where, finally?
If you are still undecided where to put in your money, a combination of both ELSS and PPF may just be the right mix for you. In accordance with your optimal asset allocation strategy, invest a part in a good ELSS scheme. This will help you to ride the growth and accumulate substantial wealth, and a part in PPF which can be a debt component of your portfolio.