During the tax-saving season, ELSS vs PPF is a very common topic of discussion. Conservative investors consider PPF better while proponents of equity investments can not see anything beyond ELSS. A number of my clients and friends inexplicably ask this question during the last quarter of financial year.
I find this question quite amusing and in fact wrong at some level. Apart from the fact that both PPF and ELSS offer tax benefits under Section 80C of the Income Tax Act, there is hardly anything in common.
ELSS is an equity product while PPF is a debt product. With PPF, returns are guaranteed while with ELSS, there is no such guarantee. ELSS investments have lock-in of 3 years while PPF matures in 15 years.
In a way, people face this dilemma between ELSS and PPF just because both the products offer similar tax benefits. If the two products didn’t have similar tax benefits, most of us wouldn’t even ask this question.
Strange, isn’t it? All along, I (and you are aware) have maintained that your investment decisions shall not be driven solely by tax considerations. Ideally, you should have financial goals and you must select investments which are suited to meet those goals. For long term goals, have an equity heavy portfolio. For short term goals, have a debt heavy portfolio. If those investments offer tax benefits, there is nothing like it.
However, is that what you are doing when you are comparing PPF and ELSS? The tax considerations are driving your investment decisions. Somehow, during tax-saving season, reasoning goes out of orbit and tax-saving becomes paramount. No one cares about financial goals.
Anyways, in this post, I will do a quick comparison between ELSS and PPF and discuss how you should approach this question.
I am saying upfront there is no crisp answer. In one of my earlier posts on tax-saving products, I had pointed out the choice or allocation varies based on your individual situation.
Let’s start with a quick recap of ELSS and PPF.
Equity Linked Savings Scheme (ELSS)
Equity Linked Savings Schemes (ELSS) are commonly known as tax saving equity mutual funds.
- There is a lock-in of 3 years. Every investment in ELSS is subject to a lock-in of three years i.e. you cannot take your money out before 3 years.
- If you are investing in ELSS through SIP, every installment of SIP is locked in for three years. For, units purchased through installment on January 15, 2016 can be redeemed on January 16, 2019. Units purchased on Feb 15, 2016 can be sold on February 16, 2019.
- Investment in ELSS is eligible for tax deduction up to Rs 1.5 lacs under Section 80C of the Income Tax Act. Do note the cap of Rs 1.5 lacs is for investment in all the products in Section 80C basket put together.
- There is no limit on the amount of investment in ELSS per financial year. You can invest even Rs 10 lacs (or even more) in a financial year.
- However, the tax benefit under Section 80C is limited to Rs 1.5 lacs per financial year.
- The returns are market-linked and are not guaranteed.
- Under the extant income tax laws, long term capital gains (holding period > 1 year) on sale of equity mutual funds are exempt from tax. Since ELSS investments cannot be sold off before 3 years, any capital gains on sale of ELSS units will be long term and hence tax-free.
- Dividend from equity mutual funds is exempt from tax. Therefore, if you opt for dividend option, dividend will be tax-free in your hands.
- Non-residents can invest in ELSS.
Must Read: 15 lesser known Income Tax Deductions
Public Provident Fund (PPF)
I have talked about PPF in many of my earlier posts. Hence, I will not cover PPF in detail in this post. Do refer to my earlier posts on PPF to know more about PPF.
A few salient points about PPF:
- PPF account matures after 15 years. So, the lock-in period for PPF investment reduces every year. However, with ELSS, every investment is subject to a fresh lock-in of three years.
- After initial maturity of 15 years, you can extend you PPF account in block of 5 years.
- There is facility of loans against your PPF balance from the third year. Partial withdrawals are permitted from the seventh year.
- You can put a maximum of Rs 1.5 lacs in your PPF account (and in PPF accounts where you act as guardian) in a financial year. Excess amount will not earn interest.
- Tax benefits under Section 80C up to Rs 1.5 lacs
- PPF falls in Exempt-Exempt-Exempt (EEE) category. Interest earned and the maturity amount is exempt from income tax.
- Returns are not fixed. Interest rate for the year is notified by Ministry of Finance, Government of India. Interest rate for FY2016 is 8.7% p.a., which is excellent for a debt product.
- Non-residents cannot invest in PPF. If the account was opened before becoming non-resident, the account can be continued with contributions till maturity.
Must Read: All you need to know about PPF
Must Read: How to use PPF as a pension tool
Must Read: Loans against PPF Account
ELSS vs PPF
Ideally, you should have crisp financial goals (children education and marriage, purchase of a house, vacation etc). And you must have assets earmarked to meet those financial goals. And yes, get the asset allocation right.
Choice of an investment product for a financial goal depends upon multiple factors including time to goal (investment horizon), risk appetite and your fiscal position.
For instance, if you are saving for own education in 2 years or even 5 years, neither PPF nor ELSS will fit the bill.
However, if you are 30 years old and are saving for children education after 15 years, you can consider PPF and ELSS. Greater exposure should be to ELSS.
If you are 55 years old and the focus is saving for retirement, invest more in PPF and less in ELSS. I assume you have a running PPF account.
Do note it is not either-or. Allocation is changing based on your specific situation.
PPF is a long term investment when you first open your account. However, as you move closer to maturity, it can even be used as a short term investment.
However, ELSS is always long term. And don’t let the lock-in period misguide you. Even though ELSS investments have lock-in period of 3 years, you must invest in ELSS only if your investment horizon is at least 7-10 years.
If PPF and ELSS were the only two assets/investments in the world, you should have invested your debt requirement in PPF and equity requirement in ELSS. No need to break your head on this. Unfortunately, life is never that simple.
Before even thinking about PPF and ELSS, check if you have adequate life insurance. If you don’t, purchase a term plan. If you are a single earning household, do consider Income Replacement Term plans too. Premium for term life insurance is also eligible for tax benefit under Section 80C of the Income Tax Act. Stay away from traditional life insurance plans or any product that provides dual benefit of insurance and investment.
If your tax quota is filled through EPF allocation, life insurance and housing loan principal repayment, there is no need to invest in ELSS. Opt for non-tax saving equity funds instead.
ELSS is no different from a non-tax saving equity mutual fund except that it provides tax benefits under Section 80C and there is a lock-in of 3 years. So, if you are not looking for tax benefits, there is absolutely no need to invest in ELSS.
However, PPF still deserves a consideration (even if your quota of 80C investments is already completed). PPF provides excellent returns for a debt product and offers a lot of flexibility once the initial maturity of 15 years is over. It can even be used as pension tool during retirement. In my opinion, a PPF account is a must for retirement planning.
In case you still have room for investments under Section 80C after EPF, life insurance and home loans, you don’t have to pick either ELSS or PPF. You can invest in both. ELSS will provide growth and PPF will provide stability to your portfolio. The exact allocation will depend on your specific situation and goals.
ELSS (or any equity investment) is primarily for growth impetus to your portfolio. You need equity investments in your portfolio to counter inflation well. Returns from PPF may not be able to do that.
And yes, if you are investing in ELSS, do not wait till the end of the financial year to invest your quota of ELSS funds. Invest regularly throughout the year through SIPs.
Identify financial goals. Get the allocation right. Pick investment products suited to meet that goal. Tax benefit is merely a bonus.
Where are you planning to invest? PPF or ELSS or both or neither.
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