Home>Blog>How do an Equity Linked Savings Scheme (ELSS) and the National Pension Scheme (NPS) compare?

How do an Equity Linked Savings Scheme (ELSS) and the National Pension Scheme (NPS) compare?

By Elricho Gomes

24th May 2022

4 mins read

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You ask an average college graduate how to file taxes, and they’ll look at you dumbfounded, ask them what the cell's powerhouse is, and they’ll answer almost in unison, “mitochondria”. This has been a running joke among most millennial and Gen-Z kids, the fact that our education system does not prioritise something as crucial as personal finance.

Taxes are a necessary aspect of a young person’s life. Getting a job fresh out of college and not knowing about taxes or how to save them can be detrimental to long-term financial health. However, a few schemes make it easier for you to invest and save taxes. This blog will spotlight Equity Linked Saving Scheme (ELSS) and the National Pension Scheme (NPS), highlighting the differences and various facilities offered.

What is an Equity Linked Savings Scheme (ELSS)?

Equity Linked Savings Scheme or ELSS is a tax saving and wealth growing investment intended for long term investors. It is an open-ended mutual fund that invests in equity and equity-related instruments, allowing investors to save on tax. While it saves taxes, it also helps create wealth in terms of long-term investments. The returns, however, aren’t guaranteed due to this scheme being market-linked. Hence those with the ability to take risks and wait for long term investments should invest in ELSS. Since these can generate higher returns than traditional tax-saving avenues, they’ve become popular among investors.

ELSS funds have the lowest lock-in period of 3 years compared to other tax-saving instruments. Under Section 80C of the Income Tax Act, 1961, investors can claim tax deductions up to Rs. 1.5 lakh. Another advantage is that an investor gets a diversified portfolio by investing even RS due to the diverse investment. 500 per month.

What is the National Pension Scheme (NPS)?

As the name suggests, the National Pension Scheme is a tax saving scheme to provide financial stability post-retirement. It is an initiative by the Central Government open to employees from the public, private and unorganised sectors. Due to the invested method, the scheme is suitable for investors with a lower risk tolerance level and who want to prepare for their retirement. Along with these securities, the NPS has a unique tax advantage where investors can claim a tax deduction of up to Rs. 2 lakh, combining Section 80C and Section 80CCD.

Upon retirement, investors can withdraw a certain percentage of their corpus and invest the remaining amount in an annuity. They will receive an amount every month as a pension.  NPS schemes can offer better returns than when You Want to Invest But Do Not Have a Large Fund:

With SIP, you can start investing a small amount, as low as Rs.500 every month, in a mutual fund scheme. You can invest a small portion in mutual funds through SIP whenever you have a steady income.

When You Want to Invest in Mutual Funds But Are Cautious:

SIP is suitable for those who want to test if mutual funds are right. By investing small amounts regularly and tracking returns, you can find if the investment is helping you with your financial objectives.

When You Do Not Wish to Take a Risk

Mutual funds and risk go hand-in-hand, but SIPs spread out the risk over a period, mitigating the risk potential. The longer your investment, the lesser the risk. Hence, the best time to start a SIP is when you want to invest in an instrument with a lower risk profile. The tax saving schemes while also giving investors an option to change the fund manager if they are not satisfied with the fund's performance. Hence, the investor can decide to invest in NPS depending on their financial needs, cost of living and earnings, and risk tolerance levels.

NPS offers two types of accounts, i.e., Tier I and Tier II accounts. The Tier I account is mandatory and a basic form of an NPS account. Tier-II accounts, however, are voluntary. Tier I accounts have a lock-in period until the investor's retirement age. Only Tier I subscribers can open a Tier II account. Moreover, Tier II accounts do not have any lock-in period or withdrawal restrictions.

What are the Key Differences between Equity Linked Savings Scheme (ELSS) and National Pension Scheme (NPS)?

Equity Linked Savings Scheme (ELSS) National Pension Scheme (NPS)
Minimum Investment Rs. 500 as SIP or lumpsum. Tier I account Rs. 1000
Tier II account: Rs. 250
Lock-in Period 3 years Retirement age or 60 years old, extendable to 70 years old/ completion of 10 years, with partial withdrawals, permitted up to 25%
Asset Allocation Predominantly 80% in equity partially, partially in corporate debt, government securities, and alternate investment funds
Risk Higher risk due to exposure to market fluctuation Lower risk due to diverse asset allocation
Management Fee 0.5%-1.5% 0.1%
Tax Benefit Up to Rs. 1.5 lakh Up to Rs. 2 lakhs
Taxation 10% over 1 lakh 40% exempted from tax with income from the annuity is taxable at the applicable slab rate.

Takeaways from the comparison

ELSS funds give higher returns than NPS and are suitable for both short and long-term goals. However, the risk is also greater than NPS. ELSS funds, unlike NPS, have a three-year lock-in period and are eligible for an 80C tax deduction.

NPS is better suited to long-term objectives such as retirement preparation. They, unlike ELSS, tend to provide consistent returns. The NPS, on the other hand, has a 60-year lock-in term, i.e. retirement age. NPS investments are also eligible for tax deductions under Sections 80C and 80CCD of the Income Tax Act

ELSS is still the preferred investment option, even though NPS offers tax benefits of up to Rs 2 lakh per year compared to ELSS's tax benefits of up to Rs 1.5 lakh. With a three-year lock-in period, the latter offers greater flexibility and the opportunity to earn higher returns.

Various tax-saving tools and investment avenues are available; one must research and compare them all to assess which one aligns with one’s financial goals and capabilities. This comparison was just a small step to help your journey toward financial stability and health.

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Made with ❤️ in India