Recent budget for FY 23-24 has made many changes in taxation under various income slabs and offered choice to the taxpayer to select between old and new tax regime. Once the taxpayer figures out and chooses to go with the old regime and use Sec 80 C for tax planning ELSS becomes a natural choice. Kindly consult your tax advisor before making the choice between old and new tax regime.
ELSS funds
ELSS funds are the best tax saving investment option. They fall under the diversified equity category as they invest 80% of their assets in equity and equity related instruments. These tax savings mutual funds qualify for tax exemption of INR 1.5 lakh under section 80C of the Income Tax Act, 1961
What are ELSS Funds?
Equity Linked Saving Schemes (ELSS) are the best tax saving mutual funds. ELSS mutual funds fall under the diversified equity mutual funds category. This equity fund invests at least 80% of its assets in equity and equity-related instruments, part of the corpus is invested in debt as well. ELSS funds provide dual benefits for its investors of capital appreciation and tax saving. ELSS mutual funds come with a lock in period of three years. Investors are allowed to claim tax deductions under Section 80C of the Income Tax Act, 1961 up to Rs. 1.5 lakh in a financial year.
Who Should Invest in ELSS Funds?
Any individual or HUF who wants to save on taxes under section 80C can invest in ELSS mutual funds. ELSS mutual funds have a certain amount of risk attached to them. This is because of the equity exposure in the portfolio. Therefore, ELSS mutual funds are best suited for individuals who understand equity asset class risk. These tax saver funds offer higher returns when compared to other tax saving schemes. Investors should have a long term horizon for their ELSS investments. Among all the asset classes that qualify for tax deduction under Section 80C of the Income Tax Act, ELSS funds have the lowest lock in period.
ELSS funds offer portfolio diversification for its investors. These tax saver funds have dedicated and professional fund managers. Small investors, too, can save taxes by investing in ELSS mutual funds through SIPs. Historical returns of Best ELSS funds have been around 15% or even higher returns.
Advantages of ELSS Mutual Funds
- Tax Benefit of ELSS Mutual Funds
Tax saving is the prime reason for ELSS being the great choice as an investment option. Investment to the extent of Rs. 1.5 Lakhs annually in ELSS qualifies for the tax deduction under section 80C of the Income Tax Act, 1961.
However, you can invest any amount in ELSS, as such there is no upper limit for investment. The investment beyond Rs. 1.5 Lakhs do not provide tax benefits.
- Lock-in Period
There is a lock-in period of 3 years associated with the ELSS investment. The lock-in period helps reinvestment of earnings and evens out the initial volatility associated with equity investments.
However, you should know that the lock-in period starts from the date of purchase. For example, if you are investing a lump sum amount of Rs. 1000 and getting 100 units on July 31, 2022. Then the lock-in period will get over on July 30, 2025.
But when you are investing through SIP every month like 10 units on July 31, 2022, 10 units on August 31, 2022, and so on. Then the lock-in period will end on – for the first 10 units on July 30, 2025, for the next 10 units on August 30, 2025, and so on.
- SIP or Lump sum
There are two methods to invest in ELSS. If you have regular income then you can invest monthly through SIP. Otherwise, if you have surplus cash then you can make a single lump-sum payment to invest in ELSS.
You can invest in ELSS through SIP for as small as Rs. 500 per month. You can check the difference between SIP and Lump sum.
- Major Investment in Equity
For generating returns, the ELSS pooled funds are invested in equity and equity-related securities. Equity instruments carry a higher level of risk than debt, bonds or money market instruments like CPs, CDs, and T-bills.
You should also check your risk appetite before investing in equity. Equity offers better returns over a period of time but can be volatile in the short term.
Likewise, you also get higher returns for investing in ELSS. ELSS gives you 15% and above returns in comparison to 8% returns of PPF and NSC.
- Tax on Returns
Not all gains from ELSS investments are tax-free. The gains from ELSS investments are treated as long term capital gains (LTCG) and any gains in excess of Rs. 1 Lakh is taxed at the rate of 10%.
- High Returns
Top ELSS funds have the potential to earn higher returns than other tax saving instruments like PPF or NPS. These high returns are a result of the risk taken by the fund houses by investing in equities. Some best ELSS funds also invest in mid cap companies. These funds can generate higher returns than funds that invest only in large cap companies. However, the risk associated with such funds is higher when compared to other funds.
- No Upper Limit
There is no maximum limit to the amount an investor can invest in ELSS funds.
- Professional Management
Professional fund managers manage ELSS mutual funds. Therefore, an investor with little or no knowledge about the markets can invest in the best ELSS mutual funds and still get maximum returns. This professional management service helps investors get higher returns compared to other traditional tax saving options.
Options for Investing in the Best ELSS Funds
There are three types of ELSS mutual funds that an investor can choose from,
- Growth Option
Under the growth option, the investor gets the gains only at the time of redemptions. Appreciation in the total NAV of the ELSS mutual fund multiplies the profits. Investors are not entitled to benefits in the form of dividends. Mutual fund returns are subject to market risks, and so are the returns from ELSS funds.
- Dividend Option
Under the dividend option, the investor is entitled to get timely dividends. Dividends are declared only when there are excessive profits. According to the budget 2020, the dividends are taxed in the hands of the investors. The investors are supposed to pay the tax on dividends based on their income tax slab.
- Dividend Reinvestment Option
Under this option, the investor can choose to reinvest dividends received into the same scheme. This option is favourable when the markets are doing well and are likely to continue in the same way.
Upon choosing the type of ELSS fund, the investor can invest either through a lump sum amount or SIPs. ELSS mutual funds are suitable for small investors as well, who wish to invest small and regular amounts to save tax. However, if an investor has a lump sum amount, they can also invest the entire amount in the top ELSS funds.
Tax Benefits of ELSS Funds
Investment in ELSS funds qualifies for tax exemption under section 80C of the Income Tax Act 1961. From April 2018, long term capital gains tax (LTCG) of 10% was introduced on equity funds. Hence once the lock in period is completed, and during redemption, the gains (if any and above Rs 1 lakh) are subject to LTCG tax of 10%. The investor can hold the investment in the ELSS funds even after the lock in period of 3 years is completed. But premature withdrawal from the ELSS funds is not allowed.
The dividends distribution tax (DDT) is removed from April 2020, and the dividends are now charged in the hands of the investors based on their income tax slab.
Can I withdraw ELSS after 3 years?
Yes, investors can withdraw their investments from ELSS funds after the lock in period of 3 years. In the case of a lump sum investment, the entire amount can be withdrawn after three years. But in the case of SIP investment, each SIP investment has to complete the 3-year term.
Comparison of ELSS with Other Tax-Saving Instruments
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. This is where ELSS stands out – its returns are generally higher, especially when the markets are on the bullish trend. This, coupled with a lock-in period of just three years, makes ELSS mutual funds the best tax-saving investment option. Even the post-tax returns of ELSS are much more attractive than that of any other tax-saving investment option.
|
Investment |
Returns |
Lock-in Period |
Tax on Returns |
|
5-Year Bank Fixed Deposit |
7% to 8% |
5 years |
Yes |
|
Public Provident Fund (PPF) |
7% to 8% |
15 years |
No |
|
National Savings Certificate |
7% to 8% |
5 years |
Yes |
|
National Pension System (NPS) |
8% to 10% |
Till Retirement |
Partially Taxable |
|
ELSS Funds |
15% to 18% |
3 years |
Partially Taxable |
Section-80C of the Indian Tax Act allows deduction up to Rs. 150,000 from your total annual income. Yet, many taxpayers find a major chunk of this getting consumed by mandatory deductions.
MUTUAL FUND SIP RETURNS
CATEGORY AVERAGE RETURNS
-CA JAYESH GANDHI
Disclaimer: This is an informative document and opinions expressed in it are our own and not any advice. We are AMFI registered MUTUAL FUNDS DISTRIBUTOR.
