NPS vs ELSS – Which is better to invest money?

NPS VS ELSS

NPS or National Pension Scheme is a government sponsored pension scheme which was made available to all the Indian citizens in the year 2009. Anyone who is in the age bracket of 18-65 years can open a NPS account. There are two types of account which one can open under NPS -Tier I and Tier II. Tier-I account is mandatory while the other is optional. Investments in Tier- I account are non withdrawable till 60 years of age as these are meant for retirement while investments in Tier-II account can be withdrawn anytime.

ELSS or Equity linked Savings Scheme on the other hand is the tax saving category of mutual funds in which the investment qualifies for 80 C deduction. They invest at least 80% of the assets into equities. They have a minimum lock in period of 3 years. One can invest in ELSS funds either in lump sum or through SIP’s. The returns offered by ELSS are entirely market linked.

Let’s now discuss in detail how these instruments are different from each other on various parameters.

1. RETURNS
The returns generated by both these instruments are market linked. There are no assured returns. Since the returns are market linked they are capable of generating inflation beating returns.

The returns generated by NPS funds over a period of 5 years are around 10- 11% CAGR while the returns generated by ELSS funds are in the range of 15-18% CAGR. The reason of underperformance by NPS funds is their large cap orientation while ELSS funds allocate some part of their assets in small and mid cap companies. Also the maximum exposure in equities in case of NPS funds is capped at 75% while there is no upward capping in case of ELSS.

Hence over a period of time,ELSS tend to outperform NPS.

2. TRANSPARENCY
ELSS is more transparent than NPS as they disclose their asset allocation every month through factsheets. This enables investor in finding fund allocation across different sectors and even the holdings in individual stocks. While in case of NPS there is as such no transparency with respect to asset allocation. Also, mutual funds are widely tracked by independent websites whereas very few track NPS.

3. CHOICES AND OPTIONS OFFERED
ELSS funds are offered by almost all the AMC’s which provide a lot of options to the investors. However in case of NPS there are only few pension fund managers, hence the choice is limited. NPS offers various fund options which invests in equities, government securities and corporate debts. There is an option to choose from two investment options available -active choice and auto choice.

In case of active choice, the subscriber is allowed to choose his own asset allocation. However the maximum allocation towards equity is capped at 75%. While in case of auto choice, the asset allocation will change as per the age of the investor. There are three kinds of funds available under the auto choice option. These are:-

a) LC 75 – Aggressive Life Cycle Fund.
b) LC 50 – Moderate Life Cycle Fund.
c) LC 25 – Conservative Life Cycle Fund.

4. TAXABILITY
The tax treatment of both the instruments has witnessed several changes over a period of time. In the recent budget, tax has been imposed on long term capital gains of over Rs 100000 @ 10%. While on the other hand the taxes on the NPS have moved on the other side. Earlier out of 60% of the corpus that can be withdrawn as lump sum, only 20% is tax free while tax is to be paid on the rest 40%. But recently the government has also made this 40% lump sum corpus tax free. Hence making NPS at par with other saving instruments. But one should remember that the other 40% of the accumulated corpus must be utilized for buying annuity in order to receive monthly pension. This monthly pension will be added to the income of the investor and is taxed as per one’s tax slab. Look at the following table:-

Apart from this, investments in both the instruments are eligible for tax deductions up to Rs 1.5 Lacs under section 80 C of the Income Tax Act 1961. However, one can avail extra deductions up to Rs 50000 u/s 80 CCD 1(b) in case of NPS.

Moreover, section 80 CCD (2) allows a salaried individual to claim even more deductions if his employer puts 10% of employee’s basic salary in NPS.

5. LIQUIDITY
In case of ELSS, the lock in period is mere 3 years while in case NPS, one has to wait till 60 years of age in order to redeem the investments. However NPS allows for premature exit only after minimum 10 years of investment with the condition that at least 80% of the accumulated corpus has to be utilized for buying annuity.

Also partial withdrawals up to 25% of the contributions made are allowed in certain cases like child marriage, children education, etc after at least 3 years of investment in NPS. Partial withdrawls are permitted only 3 times during the entire tenure of subscription.

6. COST
Mutual funds have a clear and simple cost structure. All the charges are represented by their total expense ratio which is charged on a daily basis from the fund’s NAV. ELSS funds have TER ranging from 1.05% to 2.25%.

While on the other hand the cost structure of the NPS is very complex. They charge only 0.01% as fund management charges which are probably the lowest in the industry for any equity linked instruments. However one has to pay other charges for account opening, annual maintenance, transaction charges and so on. Unlike ELSS all these charges are not built into the NAV of NPS funds. Some are charged through cancellation of units while some are deducted from investment or corpus.

FAQs

Q1. Which is the better tax saving scheme, NPS or ELSS?
A. Both the instruments allow an investor to claim deductions under section 80C up to a limit of Rs 1.5 lac. However NPS investments are also eligible for extra deductions under section 80 CCD 1(b). Hence one should opt for ELSS for exhausting their basis 80 C limit and may use NPS for claiming extra deductions up to Rs 50000 u/s 80 CCD 1(b).

Q2. With NPS declared completely tax free, is it now a better investment option than mutual funds with LTCG taxing?
A. NPS is still not completely tax free as one has to pay taxes as per their tax slabs on the monthly pension they are going to receive from the annuity (purchased with 40% of the accumulated corpus). So for an individual in the 30% tax bracket, the tax outgo will be much higher in the retirement days.
On the other hand one has to pay only 10% in taxes on gains of over Rs 100000.

Q3. Should I make investment in NPS just for sake of availing extra tax benefits?
A. Yes, one can invest in NPS if one has surplus funds and wants to avail some extra tax benefits offered under NPS. But one must make sure that the withdrawal policy of NPS suits them.

Q4. Is it compulsory to buy annuity from at least 40% of the accumulated corpus?
A. Yes, on superannuation one has to buy annuity in order to receive pension.

Q5. In case of NPS, can I get 100% of the corpus in lump sum?
A. Yes, but this is possible only in certain cases:-

• On superannuation - When the accumulated corpus is less than Rs 200000.
• Premature exit – When the accumulated corpus is less than Rs 100000.
• On death – Whole amount can be withdrawn.

Q6. Can I withdraw my ELSS investments before 3 years of lock in period?
A. No, one is not allowed to redeem ELSS investments before 3 years in any case.

Q7. How much tax will I stand to save by investing in NPS or ELSS?
A. A person in highest tax bracket will stand to save around Rs 46800 by exhausting his 80 C limit which is Rs 150000. Also one can additionally save taxes up to Rs 15600 by investing extra Rs 50000 in NPS.

Q8. Do I need to pay any charges if I invest in ELSS?
A. No, you do not have to pay any charges as all the charges are built into the NAV of the funds which are charged on the daily basis.

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