What is the Difference Betweem NPS and ELSS?

When it comes to making financial decisions, you must ensure that much of your gains are not going towards taxes. A tax-saving savings scheme contributes greatly to your financial management. Therefore, you must be aware of different strategies and investment tools that can reduce your tax burdens.

Therefore, investments in mutual funds have become a popular option these days. It offers the opportunity to increase capital wealth as well as save taxes under Section 80C of the Income Tax Act. In this article, you will learn the difference between two such options, NPS vs. ELSS.

NPS or the National Pension Scheme is a voluntary savings scheme, where individuals can save up for their retirement in a systematic manner. It is regulated by the Pension Fund Regulatory and Development Authority (PFRDA) and the central government.

When you retire, you can withdraw some of the corpus you have saved up and invest the remaining balance in an annuity. NPS provides two types of accounts, Tier I NPS account and Tier II NPS account. Tier I is mandatory and the basic kind. Its lock-in period lasts till your retirement age. Whereas, Tier II is optional and there are no withdrawal limitations or lock-in periods for it.

The Equity Linked Savings Scheme, also known as ELSS, is an open-ended mutual fund scheme that invests primarily in equity and equity-linked securities, allowing you to reduce your taxable income. Furthermore, it not only helps you to build your wealth in the long term but also saves taxes.

Since these are equity-oriented, at least 65% of the asset allocation is towards companies listed in the stock market and equity-linked securities. In addition, they have a lock-in period of 3 years, after which you can either extend the account or withdraw. It has the shortest lock-in period under tax savings investments.

The main objective of opening an NPS account is gaining financial security and stability after you retire. Therefore, people who have a low-risk appetite and want to save a substantial amount for their post-retirement life can opt for this.

Moreover, NPS offers you a tax exemption of up to ₹ 2 Lakhs with the combination of Sections 80C and 80CCD of the Income Tax Act. Therefore, if your current income falls under a high tax-paying slab, this could be a great money-saving opportunity for you.

Nevertheless, it still possesses a slight risk of market fluctuations. This is because a portion of its corpus is invested in equities, and thereby does not have a guaranteed return.

Therefore, investors with a sound knowledge of equity investments can find this option a preferable one for meeting their financial goals based on their earnings, expenditures and risk tolerance.

If you have a long-term investment horizon, you can opt for ELSS as it generates higher returns in the long run. However, the benefits do not end there. ELSS will help you save taxes under Section 80C of the Income Tax Act of 1961.

However, investing in any equity-linked instrument will expose you to great market risks. This is because the returns depend on how well your funds perform in the share market. Therefore, it would only be wise to invest if you have a higher risk appetite.

In addition, ELSS has the lowest period of lock-in under the tax-saving investment instruments. Therefore, you can have much better flexibility to liquidate or extend your account at your convenience.

Lastly, by making small monthly SIP investments in ELSS mutual funds, starting only from ₹500, even small investors can reduce their tax liability. And also, for people in the higher tax slab, ELSS can effectively reduce your taxable income by making bigger investments.

ELSS funds are useful for both immediate and long-term objectives. They also provide greater returns than NPS. These funds, in contrast to NPS, have a shorter lock-in period of three years, and investments are eligible for tax deductions under section 80C.

For long-term objectives like retirement planning, NPS may be more appropriate. They often deliver steady returns, in contrast to ELSS.  Moreover, investments in NPS are eligible for tax deductions under Income Tax Act Sections 80C and 80CCD.

As a result, before choosing an investment, you should first determine your financial goals.

Finally, if you want to save taxes, you can choose from both NPS and ELSS. However, before taking such decisions, you must weigh your financial goals, risk tolerance, earnings and other factors. For instance, the tax deduction cap for NPS is larger than that for ELSS. On the other hand, ELSS offers a higher return due to its aggressive exposure to the equity market. Therefore, the overview of NPS vs. ELSS offers a clearer idea about what advantages and limitations each of these have for you.