The debate of ELSS versus PPF got a new twist after the Budget 2018 imposed 10% tax on long term capital gains on equity funds at the time of redemption. Of course, the Income Tax Act allowed a basic exemption of Rs1 lakh per year although the benefit of indexation was taken away. Having understood the different risk profile of ELSS and PPF, does the tax on LTCG really dent the returns of ELSS versus the PPF?
ELSS versus PPF – What gives better returns in post-tax terms?
We are making a comparison of a PPF product and a diversified ELSS fund over a period of 15 years (which is lock-in for PPF). Let us see how they compare in post-tax terms.
|Amount Invested||50,000||Amount Invested||50,000|
|Section 80C Rebate||30%||Section 80C Rebate||30%|
|Holding Period (Years)||15||Holding Period (Years)||15|
|Actual Rebate||15,000||Actual Rebate||15,000|
|Effective Investment||35,000||Effective Investment||35,000|
|Annual Yield||8%||Annual Yield||14%|
|Final Sum||1,58,608||Final Sum||3,56,897|
|Basic Exemption||-||Basic Exemption||1,00,000|
|Tax Rate (0%)||-||LTCG Tax (10%)||20,690|
|Post Tax Sum||1,58,608||Post Tax Sum||3,36,207|
|Post Tax CAGR (%)||10.59%||Post Tax CAGR (%)||16.28%|
In the above example, we have factored in the impact of the tax shields of Section 80C and also the tax on LTCG payable on ELSS funds. We have considered the investor to be in the 30% peak income tax bracket but we have ignored surcharge and cess for the sake of simplicity. The tax exemption has been adjusted against the initial investment and a lower base has been considered for calculating the final Post Tax CAGR returns. Here is what you can find.
The ELSS has a better advantage over a 15-year period as time and the power of compounding really works in favour of ELSS. Also, the impact of the LTCG tax on the post-tax CAGR gap between ELSS and PPF is not much. Of course, PPF does have the prima facie advantage of being totally tax free at the time of redemption. However, the impact of the LTCG tax on ELSS returns is not significant.
ELSS vs. PPF for tax saving: How to make a choice?
With an outer limit of Rs1.50 lakhs for Section 80C, all these products end up competing with each other. Here are five parameters to make a choice.
- If you are young and just starting off on your career, then prefer ELSS over PPF. It is a better creator of long term wealth.
- For those who are having lower risk appetite, PPF may be a better choice as the product is government backed. Even in this case, ELSS works better over longer time frames.
- ELSS is equity and PPF is debt. Both these products must, therefore, fit into the overall allocation to equity and debt in your financial plan.
- When it comes to ELSS, it is best to opt for a systematic plan. It not only synchronizes with your inflows but also gives the power of rupee cost averaging.
- ELSS has the lowest lock-in period among all the Section 80C investments of just 3 years. That makes ELSS a much better source of tax benefit maximization. That must be factored into your calculations.