Different investors have different objectives regarding their investments. There are a lot of investment vehicles that contest with each other to get investor attention. Of which, equity-linked saving scheme or ELSS vs NPS or National Pension System debate tends to be one of the most common ones. Let’s explore the concept of NPS vs ELSS and see which option is suitable for you.

What is ELSS?

ELSS is a Tax Saving mutual fund that helps you save taxes. It offers a deduction from taxable income  up to Rs. 1.5 lakh under section 80C of the Income Tax Act of India. These funds work like any other mutual fund. Your money, along with other investors’, will be pooled by the fund and handled by an experienced fund manager. As the name suggests, these funds will invest most of your money in equities. Even then there is adequate diversification in ELSS.

ELSS funds are further divided into categories based on market capitalisation, sector and theme of the funds. They are a suitable option for equity-focused investors to save some tax.

What is NPS?

The National Pension System is a social security scheme initialised by the central government. Introduced for government employees at first, NPS is now open to all Indian employees from the public, private, and even unorganised sectors as long as they are Indian citizens. The only exception here is the armed forces. National pension scheme encourages employees to put aside a part of their income from time to time to build a retirement corpus. At maturity, you can withdraw up to 60% of your corpus and the rest will be converted to annuity and paid as a monthly pension.

ELSS vs NPS – Benefits of each investment

Both the investment instruments carry their own unique benefits. Let’s take a look at NPS’ benefits first.

Portability – Most pension schemes in India are limited to a section of people. Here, NPS is open to almost all Indian citizens. People from any section of the society regardless of their jobs, income, and locations can join the national pension scheme. Even Indians who are residing outside of the country can invest in the scheme as long as they have a PAN and a bank account in India.

Well-regulated – National Pension System is a government scheme, and it is regulated by the Pension Fund Regulatory and Development Authority (PFRDA), which comes under the Union Ministry of Finance. PFRDA ensures transparency in all its transactions and investors can trust it to handle their money in the best possible way. Since it is regulated by a government-supported system, there is more accountability.

Dual benefits – National pension scheme acts as both a pension scheme and an investment instrument. Your money is invested in different securities that could provide you with profits and interests. Here, the power of compounding could work really well for your money. If invested early, your money could see substantial growth over time if the markets are in favour.

Ease of access – This government-regulated system’s process of onboarding is simple and hassle-free. All you need to do is have the requisite documents ready and you wouldn’t even need to go out of your room to get started with your national pension scheme account. Even Indians residing in foreign countries can open their account easily.

Now, let us take a look at the benefits of ELSS as compared to other investment options.

Tax savings – A lot of investors have this idea that investments in equities have no way of saving you some tax. But that’s only until they hear about ELSS. These mutual funds, which primarily invest in stocks, give you a deduction from taxable income up to Rs. 1.5 lakh in accordance with the Income Tax Act of India, 1961.

Lock-in period – Usual  investments required for claiming deduction under section 80C are known for their higher lock-in periods. But for ELSS, the lock-in period is only 3 years. Three years is considered a very short period among tax-saving investments, making it more liquid than other tax saving options.

Diversification – Although ELSS funds are majorly focused on equities, there is a lot of diversification available on the basis of factors like what kind of companies they invest in.

NPS vs ELSS – The similarities

Even though each is meant for different investment goals, they carry some similarities.

Tax savings

The major similarity between them is their tax-saving component.

Section 80C of Income Tax Act, 1961 allows deduction from taxable income to the extent of Rs. 1.5 lacs if the amount is invested/ paid in specified investments..  The section covers different investment schemes such as the National Pension System, national savings certificate, public provident fund, long term fixed deposit and even ELSS. Accordingly  you can claim deduction from taxable income up to Rs. 1.5 lakh on your investment in ELSS. 

Not only that, since ELSS comes with a lock-in period of three years, withdrawals are considered as long-term capital gains and you can enjoy a tax deduction for up to Rs. 1 lakh on gains. Any profit above that limit is taxed at 10% (plus applicable surcharge and cess). 

Like said above, investments under section 80C also include investment in National Pension System tier 1 account. This means you can claim a deduction from taxable income up to Rs. 1.5 lakh of your investment in NPS. Plus, withdrawal at maturity of 60% of corpus is completely tax-free. At the same time, tier 2 NPS account has no tax breaks. This is because a tier 2 account in National Pension System is voluntary and you have the liberty to invest and reinvest in it anytime you want.

Market linked

Both ELSS and the National Pension System are market linked.

Although there are diversifications as listed above, ELSS is an equity-focused investment vehicle where the majority of your money is invested in equities. This gives ELSS an aggressive approach and it can be useful in growing your wealth over time.

In NPS too, your money is invested in securities, unlike other pension schemes. Here, you have two options to choose from. You can choose the active choice option which will give you the ability to choose a portfolio that has securities according to your investment goals and appetite. On the other hand, the auto choice in the national pension scheme will let the fund manager take care of the choice. The auto choice could be a better option for novice investors who are unsure about where to invest. At the same time, National Pension System’s active choice works better for investors who are a bit more experienced and have an idea about their investment choices.

Since both are market linked, both come with their share of risk as well.

NPS vs ELSS – The differences

The National Pension System and ELSS have a number of differences as well. Let’s take a look at some of them –

Lock-in period

As said above, ELSS has a lock-in period of three years, which is comparatively shorter compared to similar tax savings schemes.

At the same time, the National Pension System’s default Tier 1 has a lock-in period until you turn 60 years. When the fund matures, you can withdraw up to 60% of the corpus completely tax free and the rest will be paid as monthly pensions. This is primarily because NPS is more of a pension scheme than an investment tool.

The scheme’s Tier 2 has no lock-in period but there is a caveat there – it has lesser benefits compared to NPS Tier 1. Tier 2 is voluntary, and a Tier 1 account is necessary for a subscription. Tire 2 has no tax benefits. Hence, the National Pension System Tier 2 is only considered as a normal investment option, similar to an open-ended mutual fund.

Portfolio

Since ELSS is equity-focused, majority of the money is invested in equities. But when it comes to NPS, you can choose a portfolio that offers diverse investment tools including equities, corporate and government debts, alternative investments, etc.

NPS or ELSS – Which is better?

The choice between National Pension System and ELSS is entirely dependent on your investment goals. Both are well-known tax savers, and both are excellent investment options for different goals. ELSS could be a better investment option if you want to save taxes on your equity investments.

At the same time, NPS is suitable for you if you want to build a retirement corpus over time. The best way to figure this out is by talking to a financial expert who will take into consideration all your needs to figure out your goals with you. Once you have a goal in mind, making a choice becomes easier. Get help and start investing today!

To explore ELSS or tax-saving funds, click here.

To explore NPS, click here.

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