ELSS or EPF - is the classic debate. In fact, many people end up investing in both asset classes to save TAXES and also to create wealth. We always say that one should look beyond tax planning when investing. You should always look at all the characteristics and uses, risk and return of a particular asset and then make your investment decision. Lets us understand that in detail here:
What is EPF?
It is a retirement benefits scheme maintained by the Employees’ Provident Fund Organisation (EPFO). Only employees of companies registered under the EPF Act can invest in the EPF. You and your employer contribute to the EPF scheme on a monthly basis in equal proportions of 12% of the basic salary and dearness allowance. Out of the employer’s contribution, 8.33% is directed towards the Employee Pension Scheme. However, you can choose to invest only 1800 of your salary to EPF each month irrespective of 12% of basic being a higher amount.
What is ELSS?
Equity Linked Saving Scheme or ELSS is a type of mutual fund scheme that primarily invests in the stock market or Equity. As they help you save in tax, they are also known as tax-saving funds. ELSS can invest in companies across all market capitalization and hence, categorising their risk can be a bit tricky.
RISK & Return of EPF & ELSS?
EPF: For the current financial year, the interest rate on the EPF account has been fixed at 8.10%. However, the interest earnings are tax-free and hence, the effective post-tax returns are much higher. For someone in the 30% tax bracket, your post-tax returns are _____–. The Risk in EPF is close to NIL. They come with a sovereign guarantee. We know that EPF will come back to us at the end of retirement with great returns and no taxes.
ELSS: As you are investing in Equity indirectly via ELSS, the returns are not fixed. You can make high returns of 18% - 20% to also make a loss in these investments. On average Equity can give good returns of 12% - 15% when invested over a long term of 10+ years. Risk is high as the underlying in Equity.
What is the Holding Period for EPF & ELSS?
EPF: EPF accounts have a lock-in period of 5 years. However, partial early withdrawal from EPF is permitted for a child’s marriage, higher education and making a down payment for a house, subject to conditions. Basically, you cannot withdraw from EPF at your own whims & fancy.
ELSS: You have to stay invested for 3 years into an ELSS fund to continue the benefit of tax savings. However, many people believe that after 3 years you have to sell the ELSS. This is not true. You can stay invested for as long as you prefer based on your goals and market movements. There is no upper limit. In fact, if you want you can sell your ELSS before 3 years as well, you just have to bear the penalty and pay the tax you saved by investing in ELSS in the first place.
What are the tax benefits you get if you invest in EPF & ELSS?
EPF: Your contribution is exempt from tax up to 12% contribution. An employee’s contribution is eligible for tax benefit under Section 80 C of the Income-Tax Act, 1961. EPF is under the EEE norm currently indicating that the money invested, interest earned and the money withdrawn after a specified period (5 years) are all exempted from income tax in the hands of the employee.
ELSS: Amount invested in an ELSS fund is available for a tax deduction to the extent of ₹150,000 for the current financial year under section 80C of the Income Tax Act.
How can you choose between the two?
EPF over ELSS.
EPF is a great investment option for you if you are a salaried employee. Go for that 12% of your basic going towards EPF, increasing year - on- year with tax deductions and high returns. Until your retirement, EPF can be a great contribution for your financial freedom and is TAX FREE (at least your contribution upto 2.5 lakhs per annum). Whereas ELSS (do give great returns on paper) is very risky as the underlying is Equity and hence, can give higher losses as well.
The core difference between EPF and ELSS is that while the returns (post taxes) from the assets can be similar, the risk is very different. EPF gives me post taxes 12% returns fixed without any risk. ELSS can give me higher than 12% with very high risk of Equity.
Wealth Cafe Advice
We always recommend, where cashflow is not an issue, for tax saving purposes, utilise your EPF to the maximum. IF there is any shortfall, then you can opt for ELSS. Also, if your 1.5 lakhs limit for 80C is completely utilised through EPF, then do invest in other Equity Mutual Funds. Do not just invest in ELSS because returns are high. Start your tax planning in advance rather than wait for the last moment. Always remember, Tax Planning is part of your financial planning and it should meet your financial goals - do not have a standalone tax plan.