Why invest in ELSS funds?
ELSS allows Indian citizens to reduce their taxable income by Rs.1,50,000 under Section 80C. There are other investment options that help save under this same Section, but ELSS offers the lowest lock-in obligation of 3 years and the possibility of the highest returns. The funds invested in ELSS schemes are exempted from taxation, but if the returns on investment are greater than Rs.1 lakh, they are charged tax at 10% under LTCG.
ELSS funds are equity funds that invest a major portion of their corpus into equity or equity-related instruments. ELSS funds are also called tax saving schemes since they offer tax exemption of up to Rs. 150,000 from your annual taxable income under Section 80C of the Income Tax Act.
As the name suggests, an ELSS fund is an equity-oriented scheme with a mandatory lock-in period of three years. In recent years, many taxpayers have turned to ELSS schemes to avail of tax benefits. If you invest in ELSS schemes, then you can avail tax exemption of the invested amount up to a limit of Rs. 150,000. Further, the income that you earn under this scheme at the end of the three-year tenure will be considered as Long Term Capital Gain (LTCG) and will be taxed at 10% (if the income is above Rs. 1 lakh).
Some important features of ELSS funds are as follows:
A minimum of 80% of the total investible corpus is invested in equity and equity-related instruments
The fund invests in equity in a diversified manner – across different market capitalizations, themes, and sectors.
There is no maximum tenure of investment. However, there is a lock-in period of three years.
Tax exemption on the invested amount under Section 80C of the Income Tax Act.
Income is treated as LTCG and taxed according to the prevalent tax rules.
As mentioned above, Section 80C of the Income Tax Act offers tax deduction benefits on the principal invested by you in an ELSS scheme. The is a cumulative deduction benefit which means that you can avail a tax deduction of up to Rs. 1.5 lakh under the above-mentioned section for investments made in all instruments specified like ELSS, NSC, PPF, etc.
Further, these schemes have a mandatory lock-in period of 3 years. Therefore, on redeeming the units, you receive long-term capital gains or LTCG. These gains are not taxable up to Rs. 1 lakh in one financial year. Any LTCG above this limit is taxed at 10% of the gains exceeding Rs. 1 lakh without indexation.
ELSS Tax Saving Funds offer a wide range of benefits including:
Diversification – Most ELSS funds invest across a diverse group of companies ranging from small-cap to large-cap and across various sectors. This allows you to add the element of diversification to your investment portfolio.
Low minimum amount – Most ELSS schemes allow investors to start investing with as low as Rs.500. This ensures that you start investing without having to accumulate a reasonable investible corpus.
SIPs – While you can invest a lump sum amount in an ELSS scheme, most investors prefer the SIP method as it allows them to invest in small amounts and avail tax benefits along with an opportunity to create wealth.
Additionally, you can invest as much as you want but can avail tax benefits as limited by Section 80C of the Income Tax Act. Also, you can choose to stay invested after the stipulated lock-in period of 3 years for as long as you want.
You must look at the scheme’s performance over the past decade in addition to the factors mentioned below before investing in ELSS Funds in India:
Investment + Tax Planning
Being the only type of mutual fund which invests in the equity market and offers tax benefits, many investors look at ELSS funds only for tax planning purposes. If saving tax is your sole purpose, then there are several options available under Section 80C of the Income Tax Act. Before investing in ELSS, you must ensure that you primarily create an investment plan to help you achieve your financial goals. This plan will naturally include tax planning. ELSS funds can be used to achieve your long-term goals.
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In order to avail of tax benefits, many investors turn to ELSS funds at the eleventh hour. Hence, they commit the entire investment to the market in lumpsum. This is because they are in a rush to save taxes and lump sum investment is the only choice. This can be risky especially if you happen to invest at a time when the market is high. Since ELSS investments are usually linked with long-term financial goals, starting a systematic investment plan (SIP) can help you average your buying cost per unit.
Recommended Investment Horizon
Many young investors prefer ELSS funds to PPF or NSC due to its short lock-in period of 3 years. This can be a counterproductive strategy since equity investments are known to take around 5-7 years to stabilize. Being inherently volatile, keeping a short-term investment horizon with ELSS funds should be avoided.