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Happiness can come in pairs ELSS and NPS for Tax Savings

It’s that time of the year when most of us look around for investment options for saving tax. While investing, we should consider options that provide not only Tax Benefits but also have the potential to create wealth in the longer term. Amongst the various tax saving options available, Equity Linked Savings Schemes ELSS) and National Pension System (NPS) are two such popular investment avenues which could help in meeting both the above requirements. You can claim tax benefits up to  62,400 (46,800 + 15,600) in a year by investing in ELSS and NPS (apart from employer’s contribution).

Best investment tax saving options - ELSS & NPS

Equity investments with tax benefits…

Among the various tax saving investment options available, Equity linked savings schemes (ELSS) and National Pension Scheme (NPS) offer the best alternatives in terms of long term wealth creation. They offer growth potential due to allocation to equity markets which is missing in other alternatives such as PPF, NSC, EPF and tax saving FDs, which are fixed return instruments. Long term orientation of ELSS and NPS helps even out short term market linked volatility, allowing growth potential to shine through. Historically, equity as an asset class has displayed far better wealth creation potential than fixed income instruments. For instance, over the last 5 years, ELSS funds category and Equity Plan of NPS has delivered returns in the range of 12-16% CAGR. 

ELSS are diversified equity mutual fund schemes that are eligible for tax benefits under Section 80C of the Income Tax Act. It is the only fully equity investment option available under Section 80C. ELSS gives aggressive investors an ideal option to utilise tax benefit to invest in equity oriented funds. Effectively, ELSS are multicap mutual funds with a similar return profile. The lock-in period of three years is lowest among other investment options available under Section 80C of the Income Tax Act. NPS is a government sponsored pension scheme that allows subscribers to contribute periodically to a pension account. It offers options to invest across stocks, corporate bonds and government securities in the combination selected by the subscriber. The recently proposed changes in NPS to EEE status (complete tax exemption like PPF to the extent of 60% of corpus) makes it even more tax efficient. Accumulated contributions are locked in till the subscriber attains 60 years of age, after which she can withdraw 60% of the corpus tax free and the rest is used to buy an annuity for the purpose of receiving regular income during retirement. We feel ELSS and NPS can be preferred alternatives to combine tax saving with long term investment. 

Advantages of ELSS

  • Investment in ELSS is eligible for tax benefits u/s 80C. Maximum tax savings are up to |46,800 on an investment of |1.5 lakh in a FY
  • ELSS invests in equities, which have greater long term capital appreciation potential. Professional, experienced fund managers is another positive.
  • Capital gains at the end of the lock-in period are subject to 10% tax on the gains in excess of 1 lakh.
  • The lock-in period of three years is the lowest among tax saving investment options. SIP mode is also available.

Advantages of NPS

  • Exclusive deduction up to |50,000 – Additional contributions up to 50,000 in a FY can be claimed as deduction u/s 80CCD(1B). This is over and above the |1.5 lakh Section 80C limit. Maximum tax savings on this contribution would amount to |15,600 in a FY.
  • Employee share of NPS contribution (up to 10% of basic salary + DA) is eligible for tax benefits u/s 80CCD(1), within the overall limit of 1.5 lakhs available u/s 80C. Employer’s contribution is exempt u/s 80CCD (2). Self-employed persons are also eligible.
  • NPS offers a variety of choices to the contributor in terms of asset allocation and fund manager selection. Under the active choice option, investors can choose to invest up to 75% in stocks (Plan E). The investment choice and fund manager can be changed once in a FY.
  • Capital gains at end of the lock-in period on 60% of the corpus (maximum lumpsum withdrawal allowed) are completely tax free.
  • Annuity provides regular income stream in retirement.

Thus, investors can claim tax benefits up to Rs. 62,400 (Rs. 46,800 + R.s 15,600) in a year by investing in ELSS and NPS (apart from employer contribution).

Better wealth creation option

ELSS funds are the only fully equity-based investment option under Section 80C. As such, the performance potential of ELSS funds is superior compared to alternatives like Employees Provident Fund (EPF)/Voluntary, Provident Fund (VPF), Public Provident Fund (PPF) and tax-saving fixed deposits (FDs). ELSS funds have displayed a consistent performance. The category has, on an average, delivered -6.4% return over the past year, with three years, five years and 10-year CAGR returns of 10.1%, 16.4% and 17.4% respectively.

From FY17, the government has decided to market link rates on small savings instruments such as PPF and EPF, which means rates will be determined based on G-sec yields of previous three quarters. Rates would be calibrated every quarter.

It should be noted that comparison of different options based solely on past returns would be inappropriate. ELSS funds are equity based whereas PPF, EPF/VPF and tax saving FDs are non-equity instruments. Equity, as an asset class, is more volatile by nature while the performance of any equity fund is market linked. NPS is a partially equity based product with varying degrees of equity exposure depending upon the plan subscribed to. NPS also offers capital appreciation potential. Equity volatility tends to be more pronounced over shorter time frames. Performance tends to stabilise over a longer time horizon and volatility abates. We believe ELSS funds can be considered for allocation within the Rs. 1.5 lakh Section 80C limit.

Recommended Funds

  • Aditya Birla Sun Life Tax Relief 96 – Growth
  • Axis Long Term Equity Fund – Growth
  • Invesco India Tax Plan – Growth
  • ICICI Prudential Long Term Equity Fund – Regular Growth
  • HDFC Tax Saver – Growth
  • SBI Magnum Tax Gain Fund – Growth
  • DSP Blackrock Tax Saver Fund

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