While PPF is a debt product issued by post office, ELSS is a tax-saving equity mutual fund issued by registered AMCs in India.
For a very long time income-tax saving under Section 80C was all about Public Provident Fund (PPF) and a few products like Kisan Vikas Patra (KVP) and LIC policies. Tax planning stopped there and rarely crossed these boundaries. Unlike the Employee Provident Fund (EPF) which is mandatory, the Public Provident Fund (PPF) is voluntary and can be opened at the nearest post office.
How does PPF rank after the advent of ELSS?
ELSS (Equity-Linked Savings Scheme) is not new and has been in existence for more than 2 decades. It is only in the last few years with the rapid growth in the equity cult that ELSS has emerged as a solid tax-saving avenue. While PPF is a debt product issued by post office, ELSS is a tax-saving equity mutual fund issued by registered AMCs (mutual funds) in India. The difference between PPF and ELSS is that due to their investment mix, their risk profiles vastly differ. An ELSS versus PPF comparison must incorporate a number of considerations including returns, risk, lock-in period, tax benefits, liquidity, long-term wealth creation etc.
What are the risk / return implications of PPF and ELSS?
Purely on the risk matrix, PPF is more secure compared to ELSS. PPF is backed by the government of India and hence is virtually free of default. However, there is the risk of the lock-in of 15 years in PPF and the minimum withdrawal lock-in is for 7 years. During this period if the interest rates in the market go up then you are stuck at lower rates in PPF. On the other hand, ELSS is an equity-driven product and does not have any fixed return. The returns depend on the performance of the ELSS portfolio. It has been observed that over longer periods of 8-10 years, the ELSS yields around 14-15% annualized, without considering the tax exemption under Section 80C of the Income Tax Act. Also the lock-in period here is 3 years.
How do ELSS and PPF compare on tax benefits?
Let us look at tax benefits on PPF and ELSS at 3 levels; at the time of investment, when income is received and at time of redemption. Tax benefits on ELSS and PPF are largely similar. Both the investment options qualify for Section 80C exemption to the tune of Rs 150,000 each financial year. The interest on PPF and the dividends paid out by ELSS are fully tax-free in the hands of investors. However, dividends on equity funds entail a withholding tax at 10% effective Apr-18. Lastly, at the time of redemption, PPF does not attract any tax. The ELSS taxation system has changed in the 2018 Union Budget. Long-term capital gains on ELSS will be tax-free only up to an overall limit of Rs 1 lakh per annum. Any gains beyond that will attract an LTCG tax of 10%.
How do PPF and ELSS compare on liquidity?
ELSS has a lock in of just 3 years. At the end of 3 years, you may choose to withdraw the entire amount and reinvest the proceeds in an ELSS and claim the benefits under Section 80C every third year. PPF has a lock-in period of 15 years. Of course, there is intermittent liquidity facilities available like withdrawals from PPF are permitted after the completion of 7 years. Similarly, after 3 years, PPF allows you take a loan against your investment. PPF does score here too. You get funding up to 90% of the PPF balance in your account whereas funding against ELSS (post lock-in) will be limited to just 50% of the market value.
ELSS scores over PPF in long-term wealth creation
The major risk that investors are exposed to is “Not taking any risk”. Debt yields are falling consistently and PPF rates change on quarterly basis. Of course, PPF returns will also be revised upwards with rise in interest rates but that is a remote possibility with inflation at such low levels. The power of compounding works perfectly in case of ELSS. In case of PPF, with 8% annual rate of return, your long-term wealth creation is restricted.
In a nutshell, ELSS scores on 2 fronts; the outer limit for annual investment is not restricted to Rs150,000/- in case of ELSS. Secondly, ELSS fund managers can take a longer-term approach due to the mandatory lock-in and that works better for wealth creation. Of course, PPF will score on safety, security and even on tax benefits. The final decision on PPF versus ELSS will have to be taken with reference to your overall financial plan.
(By Vivek Shukla, Head of Products, Angel Broking)