Mutual funds, specifically Equity Linked Savings Schemes (ELSS), are tax-saving mutual funds that allow investors to save taxes under Section 80C of the Income Tax Act, 1961. This section provides the opportunity to reduce taxable income by investing in certain specified avenues.
What is ELSS?
ELSS stands for Equity Linked Savings Scheme, representing an equity-diversified fund connected to the stock market. It is a type of mutual fund scheme that channels investments into equity and equity-related securities.
Features:
These mutual funds in India comes with a lock-in period of three years, requiring investors to keep their money invested for a minimum of three years. The longer you hold onto your investment in these funds, the greater the potential for earning returns.
Tax Benefits of ELSS Mutual Funds:
ELSS mutual funds are the only category of mutual funds that offer tax benefits. Let’s delve into the details of ELSS tax benefits:
Section 80C Deduction:
According to Income Tax rules, investments in Equity Linked Savings Schemes qualify for tax deduction under Section 80C.
Investors can claim a deduction of up to Rs 1.5 lakh for their investment in ELSS, resulting in potential tax savings of up to Rs 46,800.
Lock-in Period:
ELSS funds come with a lock-in period of 3 years, during which investors cannot redeem their investment.
When redeeming ELSS funds after the lock-in period, investors are subject to long-term capital gains tax at a rate of 10%. However, if the gain is within the limit of Rs 1 lakh, no tax is applicable.
Advantages of ELSS:
- ELSS funds are the sole tax-saving funds within the Rs 1.5 lakh limit, offering the additional advantage of providing returns linked to equity.
- Investing in ELSS provides dual benefits – capital appreciation along with tax advantages.
- ELSS boasts the shortest lock-in period of three years compared to other tax-saving instruments such as PPF and NSC.
- As ELSS funds are linked to the equity market, they have the potential for good returns over the long term, especially if held beyond the lock-in period.
- Well-suited for investors with a moderate to high-risk appetite.
- Dividends from ELSS funds are tax-free during the investment period.
- Profits from the sale of ELSS fund units are considered long-term capital gains and are, therefore, tax-free.
Who should invest in Mutual funds?
Salaried Individuals:
If you are a salaried employee contributing to the Employees’ Provident Fund (EPF), which is a fixed-income product, and you seek higher returns on your investment portfolio, ELSS is a suitable option.
ELSS not only offers good returns over the long term but also qualifies for tax deductions under Section 80C. In comparison, unit-linked insurance plans (ULIPs) and the National Pension System (NPS) have longer lock-in periods and potentially lower returns. ULIPs have a lock-in period of five years, and NPS, primarily a retirement solution, has partial exposure to equity with funds locked until the age of 60. ELSS funds, in contrast, have the shortest lock-in period of only three years.
First-time Investors:
For new investors, ELSS is an ideal choice as it provides not only tax benefits but also exposure to equity investing and mutual funds.
While equity investments carry higher short-term risks due to volatility, over a period of more than five years, the risk diminishes. Starting with monthly SIPs in an ELSS fund allows investors to accumulate more units during market downturns and generate better returns during favorable market conditions.
How to Invest:
The optimal method for investing in ELSS funds is through monthly SIPs (Systematic Investment Plan). The minimum investment via SIP can be as low as Rs 500 per month.
At the beginning of each year, calculate the statutory deductions and determine the remaining amount from the Rs 1.5 lakh limit. Divide this amount by 12 to establish your SIP amount.
