Equity-Linked Savings Schemes (ELSS) are a type of tax-saving mutual fund that primarily allocate at least 80% of their investments to equities. These funds qualify for tax deductions under Section 80C of the Income Tax Act, allowing investors to claim benefits of up to Rs. 1,50,000. ELSS funds come with a relatively short lock-in period of three years, making them an attractive option for those seeking both tax savings and potential long-term capital growth. Let us understand what ELSS funds are, their features, tax benefits, and why they are an attractive investment avenue.
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What is ELSS Fund?
Equity-Linked Savings Schemes (ELSS) are the only mutual funds eligible for tax deductions under Section 80C of the Income Tax Act, 1961. By investing in ELSS, you can claim a tax rebate of up to Rs. 1,50,000 and potentially save up to Rs. 46,800 annually in taxes.
ELSS mutual funds allocate at least 80% of their portfolio to equities and equity-linked instruments, with the remaining portion possibly invested in debt. These funds have a lock-in period of just three years, the shortest among all Section 80C investment options. After the lock-in period ends, investors can redeem their entire investment without restrictions.
Features and benefits of ELSS Mutual Funds
ELSS funds bring a blend of growth potential and tax efficiency to the investor's portfolio. Here are some features and benefits of ELSS funds:
- Tax Benefits under Section 80C: ELSS funds offer investors a deduction of up to Rs. 1.5 lakh under Section 80C of the Income Tax Act. This makes them an effective tool for tax planning and wealth creation simultaneously.
- Shortest Lock-in Period: ELSS funds come with the shortest lock-in period among all the other 80C tax-saving instruments, standing at just three years. This gives investors the flexibility to plan their investments according to their financial goals.
- Potential for Higher Returns: Being equity-oriented, ELSS funds have the potential to deliver higher returns compared to traditional tax-saving instruments like PPF, NSC, NPS, etc. The exposure to the equity market allows investors to benefit from the growth potential of stocks.
- Professional Fund Management: ELSS funds are managed by experienced fund managers who make strategic investment decisions. This professional management aims to optimise returns and manage risks effectively.
- Diversification of Portfolio: ELSS funds invest in a diversified portfolio of equities, reducing the risk associated with concentrated investments. Diversification is a crucial factor in managing market volatility.
- Flexibility in Investment Modes: Investors can choose between Systematic Investment Plans (SIPs) and lumpsum investments based on their financial preferences. SIPs, in particular, offer a disciplined and gradual approach to investing.
- Transparent and Regulated: ELSS funds operate under the regulations of the Securities and Exchange Board of India (SEBI), ensuring transparency and adherence to investment guidelines. This regulatory oversight adds an extra layer of security for investors.
How do ELSS Mutual Funds work?
Equity-Linked Savings Schemes (ELSS) are tax-saving mutual funds that primarily invest in equities and equity-related instruments. These funds offer dual benefits—wealth creation and tax savings under Section 80C of the Income Tax Act, allowing investors to claim deductions of up to Rs. 1,50,000 annually.
ELSS funds have a mandatory lock-in period of three years, which is the shortest among all Section 80C investment options. Investors can opt for either lump sum or Systematic Investment Plan (SIP) mode. While ELSS funds offer high return potential, they are subject to market risks due to their equity exposure.
After the lock-in period, investors can redeem their units partially or fully, depending on their financial goals. Since these funds focus on long-term growth, they are suitable for individuals looking to build wealth while availing tax benefits.
Why should you invest in ELSS Tax Saving Mutual Funds?
ELSS (Equity-Linked Savings Scheme) funds are an excellent investment option for individuals seeking both tax savings and long-term wealth creation. These funds qualify for deductions under Section 80C of the Income Tax Act, allowing investors to save up to Rs. 1,50,000 annually while benefiting from market-linked returns.
ELSS primarily invests in equities, offering high return potential over the long run. Unlike other tax-saving instruments, ELSS funds come with a relatively short lock-in period of just three years. This provides liquidity sooner than options like PPF or NSC.
Additionally, ELSS investments can be made through SIPs, enabling disciplined investing and mitigating market volatility. With professional fund management, investors benefit from strategic stock selection and diversification. However, since ELSS is equity-based, returns fluctuate with market performance. It is best suited for individuals with a long-term investment horizon and moderate to high-risk appetite.
Factors to consider before investing in ELSS Funds
- Investment Horizon
ELSS funds are ideal for long-term investors who can withstand market fluctuations. While the mandatory lock-in is three years, staying invested for at least five to seven years enhances the potential for wealth creation. - Returns
Since ELSS funds invest primarily in equities, they offer the potential for higher returns compared to traditional tax-saving instruments. However, returns are market-linked and not guaranteed, making them suitable for investors comfortable with risk. - Lock-in Period
ELSS has the shortest lock-in period among all Section 80C investments—just three years. While investors cannot withdraw funds before this period, they can redeem their entire investment after three years without restrictions.
What should be the mode – SIP or Lumpsum?
Systematic Investment Plan (SIP):
- Regular and Disciplined Investing: SIP involves consistent investments at regular intervals, fostering financial discipline. Investors commit to contributing a fixed amount periodically, typically monthly, which helps inculcate a systematic and habituated approach to wealth creation.
- Mitigating Market Volatility: SIPs offer the benefit of rupee-cost averaging, a strategy that navigates market fluctuations. By consistently investing a fixed amount, investors automatically buy more units when prices are low and fewer units when prices are high, nullifying the impact of market volatility over time.
- Flexibility and Accessibility: SIPs are flexible, allowing investors to start with modest amounts and increase their investment over time. This accessibility accommodates investors with varying financial capacities, making ELSS investments more inclusive.
Lumpsum Investment:
- Capitalising on Market Opportunities: Lumpsum investments involve deploying a significant amount in one go. This approach is suitable for investors with a comprehensive understanding of market conditions and the capability to identify opportune moments for substantial investments.
- Potential for Higher Returns: While lumpsum investments expose investors to market risks, they also present the potential for higher returns. If timed well, entering the market with a lumpsum during periods of lower valuations may result in capitalising on subsequent market upswings.
- Reduced Administrative Hassles: Opting for lumpsum involves a one-time investment, reducing administrative complexities associated with frequent transactions. This simplicity appeals to investors seeking a more straightforward and hands-on approach to managing their ELSS investments.
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What is the right choice between SIP and Lumpsum?
- Investment Horizon and Goals: Investors must align the choice between SIP and Lumpsum with their investment horizon and financial objectives. SIP aligns well with those aiming for long-term wealth creation through consistent and disciplined contributions, while lumpsum might be suitable for investors with a strategic market-entry plan.
- Risk Tolerance: Assessing risk tolerance is crucial. SIP, with its rupee-cost averaging mechanism, provides a buffer against market volatility. In contrast, Lumpsum exposes investors to immediate market conditions, requiring a higher risk appetite and market understanding.
- Financial Capacity: Individual financial capacity plays a vital role. SIP caters to investors with smaller budgets, allowing them to incrementally increase investments over time. Lumpsum, on the other hand, is tailored for those with surplus funds ready for immediate deployment.
Whether you choose SIP for disciplined investing or Lumpsum for immediate capital deployment, ELSS funds offer flexibility based on your financial strategy.
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Taxation rules governing ELSS funds
Given the three-year lock-in period of Equity-Linked Savings Scheme (ELSS) funds, they exclusively yield long-term capital gains, eliminating the possibility of short-term profit realisation. The earned long-term capital gains are tax-exempt up to Rs. 1 lakh annually, with any surplus subjected to a 10% long-term capital gains tax.
In adherence to Section 80C of the Income Tax Act, investors can benefit from cumulative tax deductions on the principal invested in ELSS schemes. This deduction, capped at Rs. 1.5 lakh, extends to investments in various specified instruments, including ELSS, NSC, PPF, among others.
Additionally, ELSS schemes come with a mandatory lock-in period of 3 years. Upon unit redemption, investors incur long-term capital gains (LTCG). Notably, LTCG up to Rs. 1 lakh within a financial year remains non-taxable, while any exceeding amount is subject to a 10% tax on gains beyond Rs. 1 lakh without indexation.
Conclusion
ELSS mutual funds stand as a versatile investment avenue, offering not only tax benefits but also the potential for capital appreciation. The combination of a relatively short lock-in period and equity exposure makes ELSS funds an attractive choice for investors aiming for tax efficiency and wealth creation. Before making investment decisions, investors should carefully assess their financial goals, risk tolerance, and investment horizon.
Investment in ELSS funds is quite easy via the Bajaj Finserv platform, whether you want to invest a lumpsum amount or start an SIP. Start investing now!
