Tax planning is often a tall order for most people. However, investing in ELSS mutual funds is one of the simplest ways to get tax benefits, while making the most out of the potential of capital markets.
An equity linked savings scheme (ELSS) is a form of diversified equity fund. ELSS investments are eligible for tax exemption under section 80C of Income Tax Act. They offer a double advantage of tax benefits and capital appreciation. All ELSS investments come with a three-year lock-in period.
Why should you invest in ELSS
As already said, ELSS funds are among the best instruments to save tax under section 80C, because it reduces your tax burden and at the same time allows you to pocket the upside exploits of investing in equities. Besides, no tax is imposed on long term capital gains earned from ELSS funds. And compared to other tax saving alternatives, ELSS investments have the shortest lock-in period.
Here are the respective lock-in periods of some popular investment instruments
|Post office term deposit|
|Bank fixed deposit|
|3 years from date of allotment|
|15 years (part withdrawal after 6 years of investment)|
ELSS is usually recommended to investors who have a reasonable risk appetite. ELSS funds offer no fixed returns because they fluctuate depending upon the condition of the market. All ELSS investments are open-ended, which means, you can invest your money on any day. The net asset value (NAV) of ELSS funds, are disclosed on all business days.
Here’s a de-brief of the various options available in a ELSS fund
- Growth option: Under the growth option, income earned by the ELSS fund is not distributed to the subscribers. You earn no dividend for the entire period you hold the fund. All profits earned by the fund, enhances its NAV and losses result in lower NAV. At the time of selling the units, you will realise long term capital gains or losses.
- Dividend option: In this option, the fund distributes its income to investors as dividend. The date of the distribution is declared by the fund. But a fund with negative income, won’t be able to distribute any dividend. All dividends earned are exempt from tax in the hands of the investor.
- Dividend reinvestment option: Under this scheme, the declared dividend is reinvested in the scheme. For instance, if an investor holds 10,000 units for an ELSS fund which declares a 1.5% dividend per unit, then the total dividend of Rs 15,000 (10,000×1.5) would be reinvested as fresh purchase on behalf of the subscriber. The dividend received, which is Rs 15,000 in this case, can be claimed as deductions by the investor.
Tax benefits in ELSS
Investments of up to Rs 1.5 lakh are eligible for tax exemptions under section 80C every year. The return from investment is also exempt from tax in the hands of the investor, after the lock-in period of three years is over. In case of systematic investment plans (SIP), redemption is done on the first-in-first-out (FIFO) basis because individual SIP installments also have a three-year lock-in period.
Criteria to choose ELSS
Keep the following points in mind while investing your money in an ELSS scheme.
- AUM: The total amount of money pooled from investors and managed by the fund is called asset under management (AUM). A higher AUM means that a fund has more number of investors and enjoys a good reputation in the market. However, AUM alone cannot be the deciding factor for choosing a fund.
- Past performance: Check whether the fund has been performing well in the past and the number of years it has been in business. A three-year, five-year, and 10-year return is usually a good indicator of consistency across market cycles.
- Beta: The Beta Coefficient is used to measure volatility of the fund compared to the market. If it is less than 1, it is less volatile and if it is more than 1, it is more volatile than the market. Typically, diversified funds like ELSS would have a Beta more than 1.
Monthly Investments in ELSS
You can invest monthly in an ELSS fund on a specified date. This is possible through the SIP route. An ELSS SIP can be started with a minimum of Rs 500. The SIP mode of investment is ideal for small investors who don’t have a lump sum amount to invest. SIP brings the rupee-cost averaging benefit to the subscriber. Since the amount of investment is fixed, the units purchased vary every month depending on the fund’s NAV. When the NAV is high, you get to buy a lesser number of units. At a lower NAV, you can buy more in number, thereby averaging out the cost.
ELSS versus other Investment Instruments
|Tax exemption u/s 80C|
|Taxation for interest|
|At least 3 years|
|Rs 1.5 lakh|
*LT Capital gains & dividend are tax free
|Rs 1.5 lakh|
|Rs 1.5 lakh|
**8% compounded annually
|Rs 1.5 lakh|
***8% compounded half yearly
Key Points to Remember
- ELSS is a type of mutual fund that has a lock-in period of three years with attached tax benefits.
- ELSS has three types of investment options: dividend, growth, and dividend reinvestment.
- Investors can choose the SIP mode of investment with a minimum amount of Rs 500. But each monthly investment carries the three-year mandatory lock-in period. Pre-mature withdrawals, before the expiry of the lock-in period, are not allowed.
- The SIP option gives investors to average their cost of holdings. But investors should not back out from the SIP when markets are falling. That will negate the benefits of averaging.
- When a subscriber opts for the dividend reinvestment plan, the reinvested amount is taken as a fresh purchase. The lock-in period of 3 years is applicable from the purchase date.
- ELSS is one of the best investments to generate wealth over the mid to long term. But returns are likely to fluctuate depending upon the situation of the capital market, and the investment decisions taken by the fund manager.