Comparing National Pension Schemes and Equity Linked Saving Schemes: Which is the Right Choice for You?

 Planning for retirement is an important aspect of financial management. As one gets closer to retirement age, it is crucial to have a proper plan in place to ensure a secure future. National Pension Schemes (NPS) and Equity Linked Saving Schemes (ELSS) are two of the most popular investment options in India. While both offer tax benefits -which one is the right choice for you? In this article, we will be comparing the two schemes in detail to help you make an informed decision. We will explore the features, benefits, and drawbacks of each scheme so that you will be able to choose the right investment plan that matches your financial goals and needs.

1. Introduction to National Pension Schemes (NPS) and Equity Linked Saving Schemes (ELSS)

National Pension Schemes (NPS) are government-sponsored retirement savings schemes designed to provide individuals with a regular income during their retirement years. The NPS offers two types of accounts: Tier-I and Tier-II. Tier-I is a mandatory account with restrictions on withdrawals until retirement age, while Tier-II allows more flexibility for withdrawals.  NPS allows an individual to allocate their funds to a combination of equities, corporate bonds, and government securities. The returns on NPS investments are market-linked, meaning they depend on the performance of the underlying investments.

On the other hand, Equity Linked Saving Schemes (ELSS) are mutual funds that primarily invest in equities and equity-related instruments. ELSS funds offer tax benefits under Section 80C of the Income Tax Act, making them an attractive option for individuals looking to save on taxes while potentially earning higher returns. ELSS funds have a lock-in period of three years, during which investors cannot redeem their investments.

2. Understanding the purpose and benefits of National Pension Schemes (NPS)

The key benefits of NPS are following:

a. Flexibility- Individuals have the option to choose from various investment funds based on their risk appetite and financial goals.
NPS offers two investment choices:

I. Active Choice allows individuals to decide the allocation of their contributions among different asset classes, such as equities (E), government bonds (G), corporate bonds (C), and Alternate Assets (A). The maximum amount that can be invested across asset classes is dependent on the type of account.

Tier-I Accounts
Asset Class	Maximum Limit
Equity (E)	75%
Corporate Bonds (C)	100%
Government Securities (G)	100%
Alternate Assets (A)	5%

 

Tier-II Accounts
Asset Class	Maximum Limit
Equity (E)	100%
Corporate Bonds (C)	100%
Government Securities (G)	100%
Alternate Assets (A)	5%

II. Auto Choice invests contributions based on the individual's age, gradually shifting to safer investments as retirement approaches. The investor has the choice to choose from 1) Aggressive Life Cycle Fund, 2) Moderate Life Cycle Fund, and 3) Conservative Life Cycle Fund. These funds take different exposures across asset classes as per the age of the investor with Aggressive Life Cycle Fund having the highest equity exposure among all three.  

b. Tax benefits- Contributions made towards the NPS Tier-1 account are eligible for tax deductions under Section 80C of the Income Tax Act. Additionally, there is an exclusive deduction of up to Rs. 50,000 under Section 80CCD(1B), which is available only for NPS contributions.

c. Regular income stream- At retirement, 40% of the corpus has to be mandatorily used to purchase an annuity from an insurance company which provides a fixed income for the rest of the individual's life, ensuring financial stability during the retirement years.

In conclusion, NPS proves to be a viable option for individuals looking to plan their retirement effectively.

3. Exploring the features and advantages of Equity Linked Saving Schemes (ELSS)

Equity Linked Saving Schemes (ELSS) are investment options that offer dual benefits of tax-saving and potential capital appreciation. Made specifically for long-term investors, ELSS funds primarily invest in equity and equity-related instruments. Key Benefits of ELSS are:

a. Tax-saving aspect- Under Section 80C of the Income Tax Act, investments made in ELSS are eligible for a deduction of up to ₹1.5 lakh from the taxable income in a financial year.

b. Potential of Significant Capital Appreciation: By putting money into stocks, ELSS gives investors a chance to grow their investments. With a mandatory three-year lock-in period, ELSS encourages long-term commitment, assisting investors in staying invested through market ups and downs, which could lead to better returns.

c. Professional Money Management: ELSS funds are professionally managed by experienced fund managers who aim to generate optimal returns by carefully selecting and managing the equity portfolio.

d. Much shorter lock-in period: ELSS funds have a lock-in period of three years, which is much shorter compared to other tax-saving options like National Pension Schemes (NPS). This means that investors have the flexibility to redeem their investments after the completion of the lock-in period, providing liquidity when needed.

In summary, Equity Linked Saving Schemes (ELSS) offer tax-saving benefits, potential capital appreciation, and flexibility in investment amount.

 

4. Key Differences between NPS and ELSS

Features	ELSS	NPS
Lock-in Period	3 years	Earlier of the Retirement age, or the age of 60 years
Return Potential	High due to higher equity exposure	Dependent on asset allocation but more balanced than ELSS
Risk	High	Lower than ELSS due to a balanced asset mix but still subject to market risks
Taxation on Contribution	Rs. 1.5 lakhs deduction eligible under Section-80C	1)     Same as ELSS 2)     Additional Rs. 50,000 under Section 80CCD(1B)
Premature Withdrawal	Not allowed	Allowed subject to conditions on Tier-I account while no restriction on withdrawal from Tier-II account given it has not been used for claiming tax deductions
Asset Classes	Minimum of 80% in equity	A mix of Equity, Corporate Bonds, Government Securities, Alternate Asset Class
Taxability	10% Long-term Capital Gain tax, after exemption of Rs. 1,00,000 in any year	60% of the retirement corpus withdrawn as lumpsum is tax-free while the compulsory annuity purchased from the rest 40% is applicable to the investor’s specific tax slabs annually.
Minimum Yearly Contribution	Rs. 500 either in lump sum or SIP	Tier-I Account ·        Rs. 500 while opening account ·        Rs. 1,000 annually ·        Rs. 500 per contribution   Tier-II Account ·        Rs. 1,000 while opening account ·        Rs. Zero annually ·        Rs. 250 per contribution

 

In conclusion, when deciding between the National Pension Scheme (NPS) and Equity Linked Saving Scheme (ELSS), it is crucial to consider your individual financial goals and preferences. Both schemes offer unique benefits and cater to different investment needs.

If your primary objective is to secure a comfortable retirement, the NPS may be the better option for you. The tax benefits and flexibility in choosing investment options make it an attractive choice for those seeking stability and consistent returns over time.

On the other hand, if you are looking for potential higher returns and are willing to take on some risk, the ELSS could be more suitable. ELSS funds invest primarily in equities, offering the potential for capital appreciation.

Whichever route you choose, it is crucial to start planning and saving for your retirement as early as possible.