ELSS vs PPF: Which Tax Saving Instrument Is Better?

Benjamin Franklin once said, “…but in this world nothing can be said to be certain, except death and taxes.” While death remains inevitable, we have the power to manage our taxes smartly. Investing in various tax-saving instruments such as Equity Linked Savings Scheme (ELSS), Public Provident Fund (PPF), National Pension System (NPS), and tax-saving fixed deposits allows us to save our hard-earned money. See below more about What Should You Choose to Save Tax? in detail.

What Should You Choose to Save Tax?

Among these options, ELSS and PPF stand out as the most popular choices. Investments of up to Rs.1.5 lakh in a financial year in these two instruments qualify for tax deductions under Section 80C of the Income Tax Act, 1961. But which one is the better option? Let’s dive deeper to figure out which instrument suits your needs best.

Lock-in Period

Both ELSS and PPF come with lock-in periods, but they vary significantly. ELSS funds have a lock-in period of three years, while PPF investments come with a 15-year lock-in period. However, PPF allows partial withdrawals after the seventh year.

ELSS Lock-in Period

• Duration: 3 years
• Flexibility: You can redeem the fund’s units after three years. It is recommended to stay invested to allow your capital to appreciate over time.

PPF Lock-in Period

• Duration: 15 years
• Flexibility: Partial withdrawals permitted after the seventh year. Complete withdrawal is possible only at maturity.

Clearly, ELSS has a shorter lock-in period compared to PPF, offering more liquidity and flexibility for the investor.

Returns

Returns are a crucial factor when comparing these two tax-saving instruments. The government of India fixes the interest rate for PPF every quarter, whereas ELSS returns are linked to the equity market and are not assured.

ELSS Returns

• Market-Linked: Returns depend on the performance of the equity market.
• Historical Performance: Over the last ten years, ELSS funds have provided returns averaging 13.55%.

PPF Returns

• Government Fixed: Interest rates are determined by the government every quarter.
• Range: Historically, PPF interest rates have ranged from 7.6% to 8.8%.

According to research by Value Research, an investment of Rs.1.5 lakh annually over the past 20 years has grown to Rs.79.39 lakh in PPF. In comparison, the same investment in ELSS has increased to Rs.2.28 crore. This indicates that ELSS has significantly outperformed PPF in terms of returns.

Investment Amount

The maximum amount that can be invested in PPF is capped at Rs.1.5 lakh per financial year. However, ELSS does not have such restrictions.

ELSS Investment

• Cap: No upper limit on investment amount.
• Tax Benefit: Applicable to Rs.1.5 lakh under Section 80C, but you can invest more and earn returns on the entire corpus.

PPF Investment

• Cap: Maximum of Rs.1.5 lakh per financial year.

This makes ELSS a favorable option for those looking to invest more than Rs.1.5 lakh annually and plan for long-term financial goals.

Taxation

Tax treatment for ELSS and PPF varies, impacting the overall returns net of taxes.

ELSS Taxation

• Short-Term Capital Gains (STCG): If units are sold within one year, a 15% tax is applicable.
• Long-Term Capital Gains (LTCG): If units are held for more than a year, gains up to Rs.1 lakh in a financial year are exempt from tax. Gains exceeding Rs.1 lakh are taxed at 10%.

PPF Taxation

• EEE Category: PPF falls under the Exempt, Exempt, Exempt category which means:
  • Principal: The invested amount is exempt from tax.
  • Interest: The interest earned is also tax-exempt.
  • Maturity: The maturity amount is free from taxation.

Given this, PPF provides a tax-free return, while ELSS is subject to capital gains tax depending on the holding period and amount of gains.

Long-Term Financial Goals

ELSS

ELSS is not merely a tax-saving instrument; it also helps in achieving long-term financial goals like retirement planning. Since you can invest beyond the Rs.1.5 lakh threshold and still earn returns on the entire investment, it serves as a robust tool for substantial wealth creation.

PPF

Although PPF offers a safe and secure investment with guaranteed returns, its low contribution limit and long lock-in period may not align well with aggressive long-term financial goals.

If you are just starting your career or have no exposure to the equity market, beginning with ELSS funds is a smart choice. ELSS offers higher potential returns, greater flexibility, and is beneficial for long-term wealth accumulation. As you grow comfortable with equity investments, you can diversify into other equity funds to further achieve your financial objectives.

On the other hand, if you prefer a risk-free, government-backed investment with assured returns and tax-free interest, PPF is an excellent choice. It provides safety and stability, making it suitable for conservative investors.

Ultimately, the decision between ELSS and PPF should be based on your individual financial goals, risk tolerance, and investment horizon. This is the brief information about the What Should You Choose to Save Tax? in detail.

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