ELSS Mutual Funds - Invest in Equity Linked Savings Scheme Funds & Save Taxes

Equity Linked Savings Schemes (ELSS) are equity-based mutual funds that help investors generate wealth, get returns, and additionally save on taxes. They offer tax deductions under Section 80C of the Income Tax Act of up to Rs. 1,50,000 from your annual taxable income. 

Key Highlights:

• ELSS funds have a mandatory lock-in period of 3-years
• Returns after the 3-year lock-in are treated as Long-Term Capital Gains (LTCG).
• If the gains exceed Rs. 1,25,000/FY they are taxed at 12.5%.

What is an ELSS fund?

An ELSS fund, or an equity-linked savings scheme in mutual funds, is the only type of mutual fund eligible for tax deductions under the provisions of Section 80C of the Income Tax Act, 1961. You can claim a tax rebate of up to Rs. 1,50,000 and save up to Rs. 46,800 a year in taxes by investing in ELSS mutual funds.

ELSS mutual funds' asset allocation has a minimum of 80% of their portfolio allocated to equity and equity-linked instruments, while the remaining may have exposure to debt. These funds come with a lock-in period of just three years,s which is the shortest among all Section 80C investment options. ELSS funds can be redeemed 100% after the lock-in ends, without any limitations.

What are the Features of ELSS funds?

ELSS funds offer various features. The following are the main features of ELSS mutual funds,

• They offer tax deductions of up to Rs. 1,50,000 in a financial year under Section 80C of the Income Tax Act.
• ELSS funds have a 3-year lock-in period, and there are no provisions for premature exit.
• You can invest any amount in ELSS, there is no upper cap.
• ELSS funds are one of the tax-saving investment with the potential to offer inflation-beating returns.
• Investing in ELSS funds gives you the benefits of tax deductions and Capital Appreciation.
• The portfolio of an ELSS fund mostly consists of equities, with some exposure to fixed-income securities as well.

What are the Tax Benefits Offered by ELSS funds?

ELSS (Equity-Linked Savings Schemes) offer various tax benefits, such as

Tax Deduction Under Section 80C: ELSS Investments made in a financial year are eligible for a deduction of up to Rs. 1.5 lakh per year, reducing your taxable income.

Long-Term Capital Gains (LTCG) Tax: Gains on ELSS are subject to fall under LTCG rate of 12.5% on capital gains made in a financial year above ₹1.25 Lakh.

What are the Factors to Consider Before Investing in ELSS?

You have to consider the following factors while choosing to invest in an ELSS mutual fund:

Investment Horizon:

• You need an investment horizon of more than 5 years to consider investing in ELSS funds.
• The equity exposure of ELSS funds requires a longer investment horizon to mitigate market volatility.

Returns:

• You need to understand that ELSS funds do not provide guaranteed returns, as they depend entirely on the performance of the underlying securities.
• However, an investment horizon of more than five years can yield higher returns than any other tax-saving investment option.

Lock-in Period:

• ELSS mutual funds have a 3-year lock-in period.
• Your investments are mandatorily locked in for 3 years from the date of investment, and you cannot redeem your holdings until the end of this period.

SIP or Lumpsum: Which is Better?

SIP is the right investment mode for those unwilling to take on higher risk. When you invest through an SIP, you get the opportunity of investing in a fund across business cycles. This helps you benefit from purchasing fund units across market cycles.

You buy more units when markets are down and fewer when markets are bullish. Therefore, over time, the price of purchasing fund units averages out and ends up on the lower side.

You will benefit from this when the markets rise, as you can realise higher capital gains on redemption. This benefit is not available if you invest a lump sum.

Lump-sum investments work best when the market is going down, i.e, following a bearish trend. They also entail a longer investment horizon and higher risk.

You miss out on the opportunity to purchase fund units across business cycles, which means you need to stay invested for 5-7 years or more to realise good gains.

ELSS Vs. Other Tax-Saving Instruments: A Comparison

There are various tax-savings schemes to help you accumulate wealth over time, such as FD, PPF and NSC, to name a few. But the returns offered by these schemes are restricted. 

In ELSS, returns are generally higher, especially during a bullish trend. Additionally, ELSS funds offer some of the most attractive post-tax returns with just a three-year lock-in period. 

Note: Section-80C of the Indian Income Tax Act allows a deduction of up to ₹1,50,000 from your total annual income. Yet, many taxpayers find a major chunk of this getting consumed by mandatory deductions.

Final Word

ELSS offers the potential for high returns due to its 80% minimum equity exposure, but it also carries market risks. These schemes are ideal for long-term investors seeking both tax benefits and capital appreciation over the period.