Consider a 25-year old self-employed individual, who is looking for a tax-saving investment option. The option that he chooses should be able to create a retirement corpus. He is already investing in equities and is now considering investments between an equity-linked savings scheme (ELSS) and the national pension system (NPS).
An ELSS is a standalone stock portfolio and, in comparison, the NPS is a retirement tool offering different choices for asset allocation. By choosing an ELSS, an individual opts for a diversified equity portfolio. However, this investment is prone to market volatility and requires tuning the asset allocation over a period of time.
On the other hand, the national pension system provides investors the choice of allocating the asset from a conservative portfolio comprising government bonds to an aggressive portfolio including 50% investment in equities. Alternatively, investors may choose the default option in which the asset allocation is automatically modified over a period of time.
Shortfalls of the national pension system
- Premature withdrawal is allowed with certain limitations from the NPS account until the investors reach the age of 60 years. Although, this may seem like a disadvantage, this limitation actually helps investors create a healthy retirement corpus, which enables them to achieve financial independence during their golden years.
- The regulations related to NPS require the investors to convert at least 40% of the maturity corpus to an annuity. This conversion is beneficial for investors because it provides a regular income to them after their retirement.
Tax benefits of the NPS
Section 80C of the Income Tax Act offers tax deductions of up to INR 1.5 lacs for investments made in some of the best retirement plans in India like the Public Provident Fund and Employee Provident Fund. Under Section 80CCD(1), the government has extended the tax benefit of up to INR 1,50,000 to the NPS. Under Section 80CCD(1B), an individual may invest an additional amount of up to INR 50,000 per year in this retirement plan and avail tax benefits on it. The scheme, when launched, was an EET (Exempt-Exempt-Taxable) plan; however, it is now tax exempt up to 40% of withdrawal amount. This means that the 40% amount withdrawn as the lump sum on maturity is also tax-free, which makes it more beneficial to the investors.
Equity-Linked Savings Scheme
An ELSS is an all-equity scheme, through which investors do not have to pay any tax, including capital gains, as the investment has to be held for a minimum lock-in period of 3 years. This means that all the appreciation earned on the capital invested is not liable for any taxes, which provides a good return on investment.
The ELSS provides more versatility in terms of taxation, end use of the accumulated corpus, and a shorter lock-in period of 3 years when compared to one of the best pension plan in India, the NPS. Moreover, the limitation subjected to the accumulated corpus at the time of maturity makes an ELSS more attractive. But ELSS invests 100% in equity and thus carries more risk as compared to NPS. A small mistake towards retirement can jeopardise entire life’s savings.
To understand more about retirement planning, it is recommended that you use a retirement planning calculator, which is easily available on the Internet. This calculator can help you understand how much corpus you need to build to sustain your current lifestyle even after retirement.
To join and operate NPS online, check how to open NPS account online with fund managers.
