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Two popular investment avenues in India are Equity Linked Savings Schemes (ELSS) and Public Provident Fund (PPF). Both instruments offer tax benefits under different sections of the Income Tax Act, aiming to encourage individuals to save and invest for the future.

In this article, we’re going to explore the differences between the two, and get to know more about what each investment means for your money and portfolio.

Understanding ELSSs

Equity Linked Savings Schemes (ELSS) represent a category of mutual funds that primarily invest in equities and equity-related instruments. The unique selling proposition for these mutual funds is that they help investors save taxes under Section 80C of the Income Tax Act.

The catch is that ELSSs come with a mandatory lock-in period of three years, which is the shortest among all tax-saving investment options under Section 80C. Investments in ELSS qualify for tax deductions up to ₹1.5 lakh and long-term capital gains (if any) exceeding ₹1 lakh are subject to a 10% tax without indexation.

As is obvious, since an ELSS invests solely in equity, they have a significantly higher risk than other instruments that combine both debt and equity.

ELSS funds can either be close-ended or open-ended, meaning that you could either invest your money through a broker at the time when a new fund is offered, or you could buy units of the fund (like in regular mutual funds) through your asset management company (AMC).

What is a PPF?

Public Provident Fund is a government-backed savings scheme offered by banks and post offices in India. The interest rate on PPF is set by the government every quarter, offering a predictable and stable return on investments.

Currently, the rate offered is 7.1% per annum, compounded annually.

Since PPFs are government-issued instruments, they also come with hefty tax savings. Investors can claim tax deductions of up to ₹1.5 lakh under section 80C of the Income Tax Act with PPFs.

Any Indian citizen can invest in a PPF account. The catch with PPFs is that it comes with a 15-year lock-in period, which is extendable up to 20 years. You could withdraw your capital prematurely after the 5th year, or avail a loan with your PPF as collateral. Generally, one-fourths of your outstanding amount is sanctioned in this loan, which is payable within 36 months.

Investments in PPFs are capped at ₹1.5 lakh, which can either be invested in a lump sum or over 12 monthly instalments. Interest income generated is tax-free.

The main differences between PPFs and ELSSs

While both of these might seem to be similar financial instruments, there are some significant differences between the two:

Investment vehicle

While a PPF is a government-issued security, an ELSS is an actively or passively managed mutual fund issued by private entities. Government securities inherently carry lower risk and are more stable over the long term, while ELSSs are subject to equity market risk.

Tax savings

ELSSs offer tax benefits to the tune of ₹1 lakh, over which all income is taxable. PPFs, however, are very lucrative from a tax perspective. Not only is the ₹1.5 lakh contribution to the PPF tax deductible every year, the interest income earned on that contribution is, too.

Lock-in period

Perhaps the most relevant difference between the two is in their lock-in structure. PPFs are very restrictive instruments, locking your capital with the government for 15 – 20 years. However, ELSSs do that only for 3 years.

Liquidity and loans

While your capital is inaccessible for 15 years in a PPF, a holder can avail a loan against this investment limited to 25% of the last outstanding value. This loan is marked up by 1% to current interest rates offered in the PPF. For instance, at 7.1% return on your PPF, you can avail a loan at 8.1%. This facility is not available to ELSS investors.

Frequently Asked Questions

Can I start investing in ELSS or PPF with a small amount?

Yes, both ELSS and PPF allow investors to start with relatively small amounts. ELSS typically have lower minimum investment requirements, sometimes as low as ₹500, while PPF requires a minimum deposit of ₹500 per year.

What happens if I miss investing the maximum amount in ELSS or PPF in a given financial year?

In ELSS, missing out on investing the maximum allowable amount won’t impact your tax benefits, but you’ll lose out on potential returns. However, in PPF, missing out on contributions may affect your overall savings goal and tax benefits for that financial year.

Can I switch between ELSS funds or change my PPF provider?

Yes, you can switch between different ELSS funds or change your PPF provider. However, ensure you understand any associated costs or tax implications that might have.

Are there any penalties for premature withdrawals from ELSS or PPF?

ELSS investments come with a mandatory lock-in period of three years, and premature withdrawals before this period attract short-term capital gains tax. In PPF, premature withdrawals are restricted and may be subject to penalties unless made under specific circumstances such as medical emergencies.

What happens to my ELSS or PPF investment if I change my tax residency status or move abroad?

If you change your tax residency status or move abroad, you can continue holding your ELSS investments. However, tax implications may vary based on the tax laws of your new country of residence. For PPF, NRIs cannot open new accounts but can continue existing accounts opened while being a resident of India until maturity.

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