Equity Linked Saving Schemes are tax-saving mutual funds that can help taxpayers reduce their taxable incomes up to Rs 1.5 lakh
December, the last month of the year, is not only famous for multiple parties and vacations, but also for one of the working class’ most dreaded phase: investments and investment proofs. This is because companies usually start deducting employees’ tax outgo for the financial year January onwards if the investment proofs are not submitted for investment declarations made at start of the year. Hence, from January to March, the in-hand salary of an individual is usually lower than the preceding months.
This creates frenzy among most individuals to quickly park their money in tax-saving instruments. And it is in this frenzy that investors don’t make the best decisions by either investing in instruments with longer lock-in time frames or instruments that don’t end up beating inflation. This is where the idea of equity-linked savings scheme (ELSS) gains prominence.
What are ELSS funds?
They are tax-saving mutual funds which can help taxpayers reduce their taxable incomes up to Rs 1.5 lakh under Section 80C. ELSS funds have a lock-in period of three years. These funds invest a majority of their portfolio in equities. Investment in ELSS can be started with a minimum amount of Rs 500 and there is no upper limit for investment.
These funds will have two plan options — growth and dividend. Under dividend plan, there are further two options — dividend payout and dividend reinvestment. The dividend received from ELSS will not be taxable for investors. Investors opting for dividend option will get regular dividends as tax-free income.
However, taking dividends as profits and not re-investing again in the fund would mean the investor is losing out on the compounding effect, which the growth plan provides. Hence, the recommended mode of investment for investors is a plan for long-term wealth creation.
Advantages of ELSS
Tax-free returns: At the time of redemption, the returns earned on most tax-saving instruments attract tax-deducted at source (TDS), effectively lowering the amount you’ve earned on your investment. But this is not the case with ELSS funds as returns on ELSS funds are tax-free when redeemed after the lock-in period of three years.
Tax saving and capital appreciation: ELSS is a unique combination where an investor falling under the 30 per cent, 20 per cent tax bracket can save up to Rs 46,350 and Rs 30,900, respectively, on investment of Rs 1.5 lakh under Section 80C of the Income Tax Act. ELSS also creates wealth for investors in the long run via the compounding effect; the average one-year, three-year and five-year returns of ELSS funds have been 33 per cent, 14 per cent and 18 per cent, respectively.
Let us compare returns on an investment of Rs 1 lakh each in the tax-saving instruments three years ago. Investment in ELSS would have become around Rs 1.5 lakh today, while that of National Pension Scheme (NPS) would have fetched around Rs 1.3 lakh. Investments in EPF today, Public Provident Fund (PPF), five-year bank FD, five-year National Savings Certificate (NSC) and 10-year NSC would have been anywhere between Rs 1.25 and 1.28 lakh.
ELSS has the least lock-in period amongst tax-saving instruments, thereby making it attractive for both medium- and long-term investors compared to tax-saving fixed deposits, NSC and PPF which have a lock-in period of 5 to 15 years.
Invest as per your risk appetite: One can invest in ELSS schemes based on their risk appetite. If you want steady returns, you can invest in stable ELSS funds which have higher concentration of largecaps in portfolio. For high-risk investors, ELSS offers funds investing in high growth midcap and small-cap companies.
SIP mode of investment: One can start investing in ELSS with a small amount of Rs 500 via a Systematic Investment Plan (SIP). This will help reduce your burden of investing a lump sum amount at one go to save tax at the end of financial year.
A word of caution: One should keep in mind that there are no guaranteed returns in ELSS as they are linked to stock market. Historically, though, ELSS has been the best performing tax-saving instruments for the past 10 years compared to other tax-saving instruments such as fixed deposits, PPF and NSC but the ELSS does not assure guaranteed returns compared to other instruments.