ELSS vs PPF: Which is a better tax-saving product?

ELSS or PPF, which is a better investment for tax-saving?

This is a strange question. Apart from the tax benefit on investment, there is not much in common between PPF and ELSS.

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. If the two products didn’t have similar tax benefits, most of us wouldn’t even ask this question.

Note: Your investment decisions shall not be driven solely by tax considerations. Decide financial goals and select investments which are best suited to meet those goals. For long term goals, prefer an equity heavy portfolio (provided you have the risk appetite). For short term goals, use a debt heavy portfolio. If those investments offer tax benefits, that’s an added advantage.

In this post, let’s quickly compare ELSS and PPF and see how to approach this question.

Equity Linked Savings Scheme (ELSS)

Equity Linked Savings Schemes (ELSS) are commonly known as tax saving equity mutual funds.

1. 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.
2. 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, 2022 can be redeemed on January 16, 2025. Units purchased on Feb 15, 2022 can be sold on February 16, 2025.
3. Investment in ELSS is eligible for tax deduction up to Rs. 1.5 lacs under Section 80C of the Income Tax Act. Note that the cap of Rs 1.5 lacs is for investment in all the products in Section 80C basket put together.
4. 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.
5. However, the tax benefit under Section 80C is limited to Rs. 1.5 lacs per financial year.
6. The returns are market-linked and are not guaranteed.
7. Long term capital gains (holding period > 1 year) on sale of ELSS (equity mutual funds) are taxed at 10%. Since ELSS investments cannot be sold off before 3 years, any capital gains on sale of ELSS units will be long term and be taxed at 10%.
8. Dividend from equity mutual funds is taxed at your income tax slab rate.
9. Non-residents can invest in ELSS.

Public Provident Fund (PPF)

1. 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.
2. After initial maturity of 15 years, you can extend you PPF account in block of 5 years.
3. There is facility of loans against your PPF balance from the third year. Partial withdrawals are permitted from the seventh year.
4. 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.
5. Tax benefits under Section 80C up to Rs 1.5 lacs
6. PPF falls in Exempt-Exempt-Exempt (EEE) category. Interest earned and the maturity amount is exempt from income tax.
7. Returns are not fixed. Interest rate for the year is notified by Ministry of Finance, Government of India. Prevailing interest rate (Q4FY2022) is 7% p.a. Even though the PPF interest rate has come down over the past few years, this is still a very good rate compared to bank fixed deposits.
8. Non-residents cannot invest in PPF. If the account was opened before becoming non-resident, the account can be continued with contributions until maturity.

ELSS vs PPF

Both products have merits.

If your financial goals and asset allocation require that you invest in an equity product, you invest in ELSS. I assume you must have the risk appetite for investing in a volatile equity product.

On the other hand, if your financial goals and asset allocation are better served through a fixed income product.

It does not have to be either-or choice.

Focus on liquidity aspects too. You can’t put money you need after 2 years in either ELSS or PPF.

PPF is a special product. ELSS is not.

Why?

1. You can’t invest more than Rs 1.5 lacs in PPF per financial year. Hence, if you skip contribution this year, you can’t make up for it in the coming years. On the other hand, there is no cap on how much you can invest in ELSS.
2. ELSS is no different from a non-tax saving equity mutual fund except that it provides tax benefits under Section 80C and has a lock-in of 3 years. So, if you are not looking for tax benefits, there is no need to invest in ELSS.
3. PPF is an excellent fixed income product. Offers very good tax-free and risk-free returns for a fixed income product.
4. 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.
5. The PPF account becomes quite flexible after initial maturity of 15 years. You can extend in blocks of 5 years and continue the account for life. Withdrawal rules also become much lenient after 15 years.

Don’t let the 3-year lock-in period of ELSS misguide you. You must invest in ELSS only if your investment horizon is at least 7-10 years. 3-years is too short a investment horizon for an equity investment. And yes, if you must in ELSS, do not wait until the end of the financial year to invest. Better to invest regularly throughout the year through SIPs.

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 you thinking about ELSS or PPF

Ensure you have adequate life insurance.

If you get your investments wrong, you can still make up for your mistakes.

However, if you mess up your insurance planning, you may not get a second chance. If you are a single earning household, consider Income Replacement Term plans too.

The premium for term life insurance is also eligible for tax benefit under Section 80C of the Income Tax Act.  Better avoid 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.

However, for the reasons shared earlier in the post, PPF can still warrant an allocation even if your quota of Section 80C investments is already filled.

Where do you invest to save taxes?

Additional Read

All you need to know about PPF

How to use PPF as a pension tool?

Loans against PPF Account

Which is the best tax-saving product?