Post Budget 2016 should you choose NPS or ELSS to build retirement corpus?

Raghav is 25 and a self-employed professional. He is looking for a tax-saving instrument that will also help him build a retirement corpus. He invests in equity for the long-term, and is considering two wealth generating investment options—ELSS and NPS. Which one is more suitable for him?

ELSS is a standalone equity portfolio, while NPS is a retirement product with multiple options for asset allocation. If Raghav chooses ELSS, he will invest in a diversified equity portfolio. However, this will be subject to volatility and would call for the tuning of asset allocation over time. NPS enables a choice of asset allocation from a very conservative portfolio invested in government bonds to an aggressive portfolio with 50% in equity. He can also opt for the default option of a lifecycle product that modifies asset allocation over time.

However, NPS has two main disadvantages. First, the money cannot be accessed before retirement and at least 40% of the maturity proceeds have to be used to buy an annuity. Even if Raghav sticks to NPS until retirement, he may find the annuities available on maturity to be unsatisfactory.

NPS offers a higher tax deduction of Rs 2 lakh, after the government provided an additional Rs 50,000 tax deduction over the Rs 1.5 lakh ceiling applicable to Section 80C products, including ELSS. However, on maturity, a part of the corpus will become taxable (60%, as per the current proposal).

ELSS is an all-equity scheme under which there is no tax on capital gains beyond a holding period of one year. All appreciation in the corpus at retirement is, therefore, completely exempt from taxation.

ELSS offers greater flexibility in terms of taxation, end use of corpus and a lower lock-in period of three years. NPS offers the advantage of a readymade portfolio and higher initial tax break. However, the disadvantages faced at withdrawal make NPS relatively less attractive, especially since Raghav does not have an employer matching his contribution.