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​NPS or ELSS: which investment grows your wealth faster?

Assume a 34-year-old salaried individual takes home a monthly income of Rs 80,000. For saving taxes, he considers using the maximum permissible tax deduction of Rs 1.50 lakh as per Section 80C of the Income Tax Act, 1961. He also wants to keep aside this investment for his post-retirement days.

However, he is in a dilemma between two options, i.e., NPS vs ELSS. He approaches a financial advisor to understand and decide which is better, ELSS or NPS. Here’s a look at what the advisor may tell him about NPS vs ELSS.

What is NPS?

NPS (National Pension System) is a pension scheme backed by the government, started nearly two decades back. The minimal annual contribution allowed is Rs 1,000 in the case of NPS – Tier 1.

Where does NPS invest your surplus funds?

NPS invest your funds in a mix of equities, corporate bonds, government bonds and alternative investments. You are allowed to decide the proportion of investment.

What is ELSS?

ELSS (Equity Linked Savings Scheme) is a diversified equity scheme. This scheme comes with a lock-in of three years. Also, they are the only mutual fund that qualifies for a tax deduction as per Section 80C.

Where does ELSS invest your surplus funds?

In ELSS, a minimum of 65 per cent of the portfolio is invested in equity and equity-related securities. Also, they may have minute exposure to fixed-income assets.

ELSS vs NPS: which is better?

  1. Minimum investment

The minimum contribution permitted in Tier 1 NPS is Rs 1,000. On the contrary, the minimum investment allowed in ELSS is Rs 500 through the SIP route and Rs 5,000 in the case of lumpsum.

  1. Lock-in period

Investment in NPS is locked in until retirement or when you reach 60 years of age, whichever is earlier. However, you do not need to withdraw, as you can extend your NPS investment until you reach 75 years. Thus, you must wait to liquidate your funds in NPS.

However, you can partially withdraw your NPS investments for specific reasons like your child’s higher education, wedding, home purchase, business venture, treatment of critical illness, etc. Remember, though, that such withdrawals are allowed after three years of opening the NPS account. On the other hand, ELSS comes with a lock-in of three years. It is the lowest lock-in available among all the tax-saving investment instruments.

  1. Taxation

NPS investment has the provision to allow a higher deduction of a maximum amount of Rs 2 lakh. Under NPS, you can claim a deduction per Section 80CCD (1) with a ceiling limit of Rs 1.50 lakh, and an additional tax deduction on your investment is allowed for up to Rs 50,000 under Section 80CCD (1B).

However, under ELSS, you are allowed a tax deduction of just Rs 1.50 lakh as per Section 80C. Also note that in NPS, upon reaching 60 years of age, you are allowed to withdraw 60% of the corpus accumulated in lump sum form without incurring any tax. For the remaining 40%, you must purchase an annuity plan if the overall corpus surpasses Rs 5 lakh margin.

Thus, both investment options provide tax benefits. However, NPS gives a higher tax benefit than ELSS. Also, ELSS is taxable at 10% without indexation benefit if you earn an LTCG (long-term capital gains) of over Rs 1 lakh.

NPS vs ELSS returns – Which one is better?

The decision between ELSS and NPS depends on how financially responsible and disciplined you are. NPS locks your funds until you reach 60 and restricts investment in equity and equity-linked funds to up to 75%. Moreover, this instrument follows a conservative outlook and does not invest your money in small and mid-caps.

The tax-saving ELSS fund may be a better choice if you’re looking to invest for the long-term horizon and have a higher equity exposure. Routing for the ELSS option will allow you to accumulate a more considerable corpus for retirement.

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