Old vs new tax regime: Why PPF still holds ground while ELSS loses appeal

This new optional tax regime offered taxpayers lower tax rates in exchange for foregoing most tax deductions and exemptions under the then-prevailing old tax regime. Its newness and the fact that the old regime still remained more attractive for most people made the shift infeasible.

However, the government brought in changes to make the new regime more attractive, encouraging more people to adopt it. It became the default tax regime from 1 April 2023.

Among the key changes that take effect from 2025-26 are: zero-tax liability for those with business and professional income of up to ₹12 lakh per year ( ₹12.75 lakh for the salaried), thanks to a higher rebate under section 87A of the Income Tax Act, and wider and more relaxed slab rates.

The changed slab rates will ensure that even with the same income as before, many taxpayers will face a lower tax rate. For example, in 2024-25, incomes of over ₹10 lakh to up to ₹12 lakh faced a 15% tax. From 2025-26, these will face a 10% tax. Similarly, from 2025-26, the 30% rate will apply only to incomes exceeding ₹24 lakh a year (up from the earlier ₹15 lakh).

Mint spoke with a few people who have already shifted to the new regime or have opted for it in the current fiscal year.

The benefit of lower or almost similar tax liability, minus the hassle of submitting documentary proofs for claiming tax deductions, has been the motivating factor for them. Plus, they have the flexibility to invest in products they find suitable rather than tie themselves to tax-saving investments. And even though the new tax rates do not incentivize them to invest, they continue to save and invest diligently.

Why the shift to the new tax regime

For 30-year-old Nitya Balasubramaniyan, an employee at a leading private sector bank, the first year of shift was more of a trial than anything else. But the second year brought tax savings. “After my income rose, my tax rate was lower under the new tax regime. There are also no mandatory tax savings to be done. So, I could make investments based on my goals." She has diversified away from equity-linked savings scheme (ELSS), a tax-saving mutual fund (MF) scheme, to other mutual fund schemes.

For Sharan Ghatge, a 31-year-old Chennai-based IT professional, the new tax regime holds the attraction of less paperwork. “Only if I were able to claim the full HRA (house rent allowance) amount, then the old regime would have been better. Otherwise, there is not much difference in my tax amount between the two regimes," said Ghatge.

Many employees either pay lower rent or have salary structures where basic pay is higher, which limits the utilization of the HRA exemption, said Sudhir Kaushik, co-founder and chief executive at TaxSpanner.com. "Many people’s preference for owning rather than renting, even when it leads to higher tax savings, is another reason for this."

HRA exemption is allowed only under the old tax regime.

No incentive to invest in ELSS

Tax deductions of up to ₹1.5 lakh a year under section 80C of the Income Tax Act are allowed only under the old regime. Investments in ELSS are covered under this. ELSS are diversified equity mutual fund schemes that invest across large-, mid- and small-cap funds, and come with a three-year lock-in.

All taxpayers we spoke with have largely stopped investing in ELSS funds since they moved to the new regime, and rightly so.

Where are they investing, instead?

“I have redeemed most of my ELSS money, though; there is still some locked in. Even after the three-year period is over, I will wait for some appreciation before I redeem it." The 30-year-old now deploys this money in large-cap index funds tracking the Nifty 500, S&P 500, and the Sensex. Some of it goes into direct stock picking, too, mainly large-cap stocks.

It is likewise for Ghatge, who has moved away from SIP (systematic investment plan) in ELSS funds to Nifty 50 index funds. That apart, as and when he finds the right opportunities, he puts some lump sum in thematic funds.

In Balasubramaniyan’s case, what was going into ELSS funds is now spread across sectoral funds (around 80%), flexi-cap funds, gold and silver exchange-traded funds (ETFs), and a bit in ELSS, too. She said she closely tracks the sectoral funds. “We put a lot of effort into earning money; we should put the same effort into investing it."

She has investments in the National Pension System (NPS), Public Provident Fund (PPF), and bank deposits, too.

Commenting on her investments, Kalpesh Ashar, a certified financial planner and Sebi-registered investment adviser, said: “The exposure is highly skewed towards sectoral funds. A more ideal mix would be 30% each in large-cap and flexi-cap funds, 15% each in small- and mid-cap funds, and 10% in sectoral funds. This can be an aggressive but prudent way of long-term equity allocation."

PPF and NPS are still attractive

All people we spoke with still find the PPF an attractive debt investment option. Gawde has been raising his PPF contribution over the years. “It is a 15-year compounding machine. I even plan to extend my PPF every five years after the 15-year lock-in is over."

One can extend the tenure of their PPF account in blocks of five years (any number of times) after the 15-year period is over.

Ghatge, however, has been making a relatively small contribution to the PPF and plans to continue with that. “The PPF is a very good scheme, but given my family commitments, putting large sums in the PPF affects my cash flows. I park money in debt funds and fixed deposits for my short-term and emergency needs."

Balasubramaniyan, who had been investing in the NPS (All Citizen Model) in her individual capacity, migrated to the NPS (Corporate Model) offered by her employer after she moved to the new tax regime. With this, she continues to enjoy some NPS-related tax deductions even under the new tax regime.

The NPS can help you build a retirement corpus by way of regular contributions during your working years. Among the very few tax deductions that are permitted under the new tax regime is a deduction of up to 14% of basic salary plus DA contributed by an employer towards an employee’s NPS (section 80 CCD(2)) in the hands of an employee. Under the old regime, a deduction of up to 14% is allowed only for government employees.

“The enhanced limit of 14% for private sector employees is only under the new tax regime and serves the dual purpose of promoting NPS investments and opting for the new tax regime," said Deepashree Shetty, partner-global mobility services, tax and regulatory advisory, BDO India.

Losing the discipline to save and invest

While the people Mint spoke with continue to invest diligently, that may not be the case for everyone. One person, who did not wish to be named, pointed out how his younger, newer colleagues with incomes of around ₹12 lakh find the new tax regime very convenient. “Since they don’t need to pay any tax, they don’t feel the need for any long-term investment planning," he said.

With the compulsion to invest in order to save taxes gone under the new tax regime, many run the risk of underinvesting for their future. So what do you do?

“Investing needs to be goal-based and should not be linked to tax planning," said Ashar.

While tax savings may no longer be the primary objective of your investments, investing towards your goals remains important. “The simplest way to begin would be to start a SIP in an index fund, even if it is for as little as ₹500 a month. Ideally, this investment should be for the long-term, but mutual funds offer liquidity whenever needed," added Ashar.