ELSS vs NPS vs ULIP: Quick points to decide between these three tax saving investments

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Updated: April 15, 2019 5:09:53 PM

Those investors who are not conservative in their investment approach and have at least ten years to achieve their goals, market-linked tax savers may serve the twin needs of tax saving and accumulating wealth for future goals.

 ELSS, NPS, ULIP, tax savers, Section 80C, Online UlipsELSS, NPS and Ulip are the three prominent market-linked tax savers with Section 80C tax benefit. Here are few watch outs before you choose any one of them.

For those looking to save tax under Section 80C of the Income Tax Act 1961, in the financial year 2019-20, there are three prominent market-linked tax savers to choose from — Equity Linked Saving Scheme (ELSS), National Pension System (NPS) and Unit Linked Insurance Plan (Ulip) — which come with tax benefits, but the returns unlike fixed-income tax savers are not fixed and assured.

Those investors who are not conservative in their investment approach and have at least ten years to achieve their goals, market-linked tax savers may serve the twin needs of tax saving and accumulating wealth for future goals. Several studies done in the past have shown that equities as an asset class have generated high inflation-adjusted returns than other asset classes in the long run.

All the three market-linked tax savers come with Section 80C tax benefit but none of them carry any assured return and even the returns in them can be volatile especially in the short-medium term. Let’s visit each of them and see what they are, how to choose them and whom they suit.

1. Equity Linked Saving Scheme (ELSS)

ELSS is a mutual fund scheme and therefore it is a market-linked investment that comes with a lock-in period of three years. That, however, does not mean that the investor will have to compulsory redeem them after the lock-in ends. As an investor, once the lock-in period ends, one may continue the ELSS scheme as an open-ended scheme. This move is actually helpful if the markets are down after the lock-in ends. Stay put and let the market recover to redeem the ELSS units later on over the long term.

Before investing in ELSS, understand the risk factors and where exactly will your money be invested. As per SEBI rule, ELSS is allowed to be invest 100 percent in equity shares, thus returns in the short-to-medium term can be volatile as is the nature of equity asset class.

As on February 4th, 1-year return in ELSS category is about a negative 10 percent, the 3-year and 5-year annualised return is about 13 percent and 15 percent respectively. Be ready to take the short-term volatility in ELSS in your stride.

What to do: Diversify across at least two ELSS schemes so that you have exposure in different sectors and stocks and fund manager’s investing style. Choose schemes that have track record of long term consistent performance. Importantly, make sure that the schemes opted are not exposed to large or mid-cap stocks only but are diversified across market-cap.

Also Read: ELSS Tax Saving: What can make Mirae Asset Tax Saver Fund your first choice

2. National Pension Scheme (NPS)

NPS, a retirement focused market-linked pension scheme is managed by Pension Fund Regulatory and Development Authority (PFRDA). The investments are allocated across equity and debt funds till the age of 60. The maximum that can go into equities is 75 percent of one’s contribution and it tapers off as one age. Further, NPS currently follows passive approach for investing. As per the new rules, on maturity, one will be allowed to withdraw 60 percent of the corpus as tax free amount, while on the balance, one starts getting pension for lifetime from a life insurance company.

As on December 31, 2018, annualised average return (since inception ) in Tier I, Scheme E (Equity) was about 10.5 percent.

What to do: Do not invest in NPS solely from the point of view of saving taxes. Estimate, how much you need to invest to meet inflation-adjusted post-retirement needs and then allocate a portion towards NPS in addition to your savings in equity mutual funds.

Also Read: NPS Contribution: Confused in selecting investment options, fund manager? Don’t worry, default options can help you

ELSS and NPS – The basic difference
While ELSS provides 100 percent exposure to equities, in NPS the maximum allocation to equities is age-dependent and has to be below 75 percent at any point of time. It, therefore, suits an aggressive investor.

Further, while the fund manager play a big role in determining returns as there is active fund management in ELSS, in NPS, its passive fund management as allocation is strictly index-based. It, therefore, suits a relatively less aggressive investor.

The fund proceeds in ELSS can be had in lump sum or spread across different years to take care of regular income need and taxation. In NPS, while 60 percent can be taken as tax-free lump sum, the annuity on the balance is entirely taxable in the year of receipt.

3. Unit linked insurance plans (Ulip)

Ulips are market-linked investment cum insurance plans that suit investors who are not financially disciplined and not comfortable in keeping investment and insurance separate. In addition to investing in Ulip, one needs to buy adequately life cover preferably through a pure term insurance plan. Similar to NPS, the ulip offers various fund options but the funds are actively managed by the fund manager in them.

Also Read: Online Ulips are cost-efficient and tax-friendly: Still, should you invest in them?

What to do: Opt for low cost online ulips and be invested in the all-equity fund option till about three years away from maturity. Thereafter, through de-risking process shift funds to less volatile debt funds.

While ELSS should remain one’s first choice of aggressive investors, NPS and Ulip suit those who do not have the time and financial discipline to invest on their own by carefully selecting the right scheme from amongst thousands of schemes available in the market.

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