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PPF vs ELSS- Which Is A Better Tax-Saving Investment Option?

One of the most significant aspects of financial planning is tax-saving. Investors are always looking out for investment schemes that help them to save taxes. When it comes to choosing the best tax saving scheme, there is a lot of confusion between two of the most popular financial instruments- PPF and ELSS.

While both PPF and ELSS are great tax saving schemes, they have entirely different goals. PPF comes with zero risks and volatility at the cost of returns, whereas ELSS with it's high returns is best for long term goals. However, investors have to bear the volatility of capital markets when they invest in ELSS.

In this post, we are going to compare both these options in more detail, in terms of meaning, features, benefits, etc., to make the choice easier for you.

What Is an Equity Linked Savings Scheme or ELSS?

Equity Linked Savings Scheme or ELSS are equity diversified mutual funds with a three-year lock-in, which means the investor cannot sell their investment before completion of three years from the date of purchase.

With their performance linked directly to the market, a significant portion of the ELSS investment goes towards equity, making the returns depend on market volatility.

How Does It Help You Save Tax?

Investments in ELSS up to Rs. 1.5 lakh per year qualify for income deductions under section 80C of the Income Tax Act, 1961. This means that you can deduct the amount you invest in an ELSS from the total income to reduce your taxable income and, hence taxes.

Let's understand this better with an example-

Varun is senior bank manager with a taxable income of Rs. 15 lakh a year. and comes in 30% tax bracket.

He decided to invest Rs. 1.5 lakh in an ELSS fund. Under 80C of the income tax act, this lowers down his taxable income to Rs. 13.5 lakh and translates into a saving of Rs. 46,800.

Features of ELSS

  • High Returns - Historically, ELSS mutual funds are known to deliver the highest returns in the category of tax-saving products. The ELSS schemes in the past few years have consistently generated 11-14% returns (on an average) in 3-5 years time frame. However, it is essential to note that by being linked to markets, ELSS returns are not guaranteed.
  • Shortest Lock-In Period - ELSS investment comes with the shortest lock-in of only 3 years among all Section 80C investment options. This makes ELSS a relatively more liquid investment choice where you can redeem your funds in just 3 years.
  • Offers Better Scope for Long-Term Wealth Creation - Although the risk involved with ELSS is higher as compared to a PPF, the returns are significantly more, too. Especially suitable for investors with a high-risk tolerance, you can start investing in ELSS either through SIP (Systematic Investment Plan) or lump-sum amount. ELSS investment offers both flexibility and convenience of making small but regular investments with an amount as low as Rs. 500 per month through the SIP.
  • Tax Benefits u/s 80C of Income Tax Act 1961 - ELSS contributions of up to Rs.1,50,000 per year are tax-exempt under the Section 80C of the Income Tax Act, 1961. However, with 10% LTCG (Long Term Capital Gains) tax applicable on the gains exceeding Rs.1 lakh a year, the returns on ELSS are not entirely exempt from taxes.

What Is a Public Provident Fund (PPF)?

Introduced by the Government of India, Public Provident Fund (PPF) Is a pure debt product that offers assured returns to the investors. Apart from this, the scheme also provides added tax benefits u/s 80C. The PPF scheme is available for all the citizens of India except NRIs. The interest rates on PPF are set by the government on a quarterly basis.

Features of PPF

  • Tax Benefits u/s 80C of Income Tax Act, 1961 - As an investment scheme, PPF falls under the Exempt-Exempt-Exempt (EEE) category, meaning all deposits made in the PPF are deductible under Section 80C of the Income Tax Act. Additionally, the accumulated amount and interest in a PPF scheme is also exempt from tax at the time of withdrawal. Put simply, when you make PPF deposits up to Rs. 1.5 lakh, you are eligible to avail tax benefits under section 80C of the Income Tax Act. Further, the interest credited every month and the maturity amount is also exempted from any tax.
  • Fixed Returns - One of the highlights of PPF as an investment vehicle is fixed returns in the form of interest every year. The interest rate on PPF is generally set by the government every quarter. On average, the returns on PPF have been around 8% (for the last 5 years). The current PPF interest rate stands at 7.9 % per annum (compounded yearly) applicable from 01.07.2019.
  • Low-Risk Investment - The fact that PPF deposits and returns are government-backed makes it one of the safest investment options. Further, the safety of capital and returns makes PPF an immensely popular investment option despite low returns as compared to ELSS.
  • Lock-in Period - There is a mandatory lock-in period of 15 years on PPF deposits. However, investors are allowed to take a loan on their PPF deposits from 3rd to 6th financial year from the year of account opening. From 6th year onwards, they can make a partial withdrawal but only up to a pre-specified limit.
  • Investment and Withdrawal Limits - A single PPF account allows a minimum investment of Rs 500 and a maximum investment of Rs 1.5 lakh. One can make a maximum of 12 contributions in their PPF account whose total does not exceed Rs. 1.5 lakh. If you wish to withdraw the amount, partial withdrawals are allowed after 5 completed years since the end of the account opening year. Premature closure of PPF accounts is only allowed in specific instances such as serious ailment.

What Should You Choose - PPF or ELSS?

While both PPF and ELSS are extremely tax-friendly instruments, the final choice should be based on parameters such as risk appetite, return expectations, and investment time horizon.

ELSS investments are subject to market risks, but still offer better wealth creation potential and more liquidity compared to PPF. PPF is generally suited for investors with zero risk appetite and willingness to invest in a scheme with a 15-year lock-in period. In contrast, investors who wish to earn higher returns and are willing to take a moderate amount of risk can opt for ELSS.

Differences Between PPF and ELSS

DifferencePPFELSS
Return on investmentModerate - Returns are fixed by the government every quarterHigh - Linked to markets and grow over a long-term horizon
SafetyHigh - Government-backedLow - Based on markets
LiquidityLow - Partial withdrawal is allowed from 6th year onwards from account opening yearHigh - Can withdraw anytime after the lock-in period of 3 years
Lock-in period15 years3 years
Tax on returns and maturityCompletely exempt10% long term capital gains tax (initial 1 lakh is exempt from tax)
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