Personal Finance

How do you choose among PPF, NPS and ELSS for tax-saving purposes?

Anand Kalyanaraman | Updated on December 06, 2020

I am an IT employee working in Bengaluru. I used to buy tax-saver FDs every year to save taxes on income up to ₹1.5 lakh. I heard about PPF, NPS and mutual funds recently. However, I am not able to understand the differences, or which would be best for me. Please let me know. Also, please let me know how I can save taxes using investment instruments other than the ones covered under Section 80C?

Tevin Joseph

It’s good that you are making use of Section 80C of the Income Tax Act. Deploying money in instruments listed under this section can help in two ways. One, the wide range of instruments under Section 80C can help plug gaps in your portfolio and build a long-term corpus. Two, the tax break on money deployed up to ₹1.5 lakh a year in Section 80C instruments can help reduce your tax outgo.

Depending on your income slab, the annual tax savings on deployment of ₹1.5 lakh under Sec 80C can range from ₹7,800 (for those in the 5 per cent slab) to ₹46,800 (for those in the 30 per cent slab).

Note that the tax deduction under Section 80C is available only for those in the existing tax regime (that has higher tax rates along with benefit of tax deductions and exemptions). If you opt for the new tax regime (that has lower tax rates but without the benefit of most deductions and exemptions), the Section 80C tax break is not available.

Section 80C instruments can be expenditure-, insurance- or investments-based.

Home loan principal repayments/prepayments and tuition fee payments for your children are examples of spend-based instruments. Insurance-based instruments include pure term life insurance plans, traditional life insurance plans and unit-linked life insurance plans.

The chunk of 80C instruments is though investment-based. These include the Employees’ Provident Fund (EPF), Voluntary Provident Fund (VPF), Public Provident Fund (PPF), tax-saver bank and post office deposits, pension plans, National Savings Certificates (NSCs), Senior Citizen Savings Scheme (SCSS), Sukanya Samriddhi Yojana, National Pension System(NPS) and equity-linked savings schemes (ELSS).

ELSS mutual funds invest in equity; pension plans such as the NPS allow equity investments, too. EPF, too, invests in equity to a small extent. The other investment-based instruments put money in relatively safer debt avenues.

There is no one-size-fits-all approach when it comes to 80C instruments. Decide based on your age, investment objectives, risk profile, return expectations, liquidity needs and gaps in your portfolio.

First, if you have dependents and are not sufficiently insured, it’s good to take adequate life insurance through online termplans. The premium paid on these is eligible for the 80C deduction. Next come the investment options.

PPF, NPS

If you don’t have early liquidity needs, the PPF is among the best debt options under 80C.

With a 7.1 per cent tax-free return for the October-December 2020 quarter (this can change each quarter) and annual compounding, the PPF can help build a long-term corpus. The tenure of a PPF account is 15 years and it can be extended in blocks of five years. PPF enjoys an exempt-exempt-exempt (EEE) tax structure — the investment gets you a tax break under Section 80C, and there is no tax on both the interest accrued and the maturity amount.

The NPS, a very cost-effective pension plan, is another long-tenure investment option that can help you plan for post-retirement income. Depending on your risk appetite, you can choose from among various schemes that have different allocations to debt and equity.

The returns on the NPS are market-linked and get added to the corpus over the years; they are not paid out regularly. On retirement, up to 60 per cent of the corpus can be withdrawn tax-free, and annuity has to be bought with the balance 40 per cent corpus. The annuity income is taxable though.

ELSS

ELSS schemes invest in stocks and are suitable for those with a higher risk appetite and a long-term horizon. If you do not have adequate exposure to equity, make use of the Section 80C opportunity to adjust your asset allocation and invest in well-run ELSS plans offered by mutual funds. The risks are higher but so are the potential returns.

ELSS funds have a lock-in period of three years. You could go for systematic investment plans (SIPs) in ELSS plans to ride out volatility in the market, but each SIP investment will have a lock-in period of three years.

The tax-saver five-year fixed deposits with banks and post offices are also a good option for conservative investors with a medium-term horizon. The investment gets the 80C tax break, but the interest is taxable.

While Section 80C is a good starting point, do invest beyond these instruments as per your capacity and accumulation targets, even if you don’t get tax breaks on the additional deployments. This will help you accumulate your intended corpus and maintain your lifestyle in the long run.

Apart from 80C instruments, there are other ways to save taxes.

Send your queries to personalfin@thehindu.co.in

Published on December 05, 2020

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