ELSS Mutual funds: All you need to know

What are Equity Linked Saving Schemes (ELSS) Mutual Funds?

An Equity Linked Saving Scheme is a type of equity mutual fund in which one can invest money and qualify for a tax deduction up to Rs. 1,50,000 under Section 80C of the Income Tax Act, 1961.

Which are the top ten Tax Saving Funds for the FY 2019-20?

Data Source: Value Research. Note: Returns data is based on NAV (Net Asset Value) of direct plan – growth variant of the schemes as recorded on Nov 26, 2019. AUM data is as of Nov 26, 2019.

How is ELSS used for Taxation?

The amount of money invested by an individual during a given FY can be claimed as a deduction up to Rs. 1,50,000 under Section 80C of the Income Tax Act, 1961.

Simply put, the amount invested in ELSS can be reduced from your gross total income to reduce your net taxable income and the subsequent taxes payable on the same.

Let’s look at an example:

Mr. Q earns Rs. 12,00,000 as salary during the FY 2019-20. He has made investments during the year as follows:

1. 15,000 towards Life Insurance Premium
2. 50,000 towards Principal Repayment towards Home Loan

Case 1: Mr. Q does not make any investments towards ELSS. His tax liability for the year will be as follows:

Case 2: Mr. Q makes an investment towards ELSS of Rs. 75,000. His tax liability for the year will be as follows:

From both cases, we can see that Mr. Q is effectively saving Rs. 23,400 (Rs. 1,56,000 less Rs. 1,32,600).

What are the Advantages of ELSS?

ELSS is considered one of the best tax-saving instruments under Section 80C of the Income Tax Act, 1961 because of the following reasons:

1. Lock-In Period

Compared to all the other options available like Fixed Deposits, National Pension Scheme (NPS), Public Provident Fund (PPF), etc., ELSS has the shortest lock-in period of 3 years. This provides great flexibility in the medium term.

2. High Returns

ELSS has the potential to give much higher returns than other tax saving options due to being linked to the market. ELSS portfolios consist of equity instruments that can provide you with returns that range from 15 percent to 18 percent. The table on the top ten tax saving funds gives us a good idea of the kind of returns one can expect.

3. Taxation

We have extensively covered the deduction available for investments in ELSS but have not covered taxation of gains made on the initial investment.

Since ELSS has a lock-in of 3 years, the gains will be taxed as long term. All gains made up to Rs. 1,00,000 are tax free and any gains beyond Rs. 1,00,000 are taxed according to the provisions of the Act.

4. Systematic Investment Option

Out of all the tax-saving investment options, ELSS is the only one that comes with a Systematic Investment Option (SIP). An investor can put in as less as Rs. 500 every month into ELSS along with the power of compounding.

What are the Disadvantages of ELSS?

There are a few minor drawbacks to investing in ELSS which are:

1. Risk

Investing in ELSS has a certain degree of risk associated with it due to its involvement in equity and other related securities, and the level of risk depends upon the scheme chosen. A national savings certificate is inherently less risky than an ELSS.

2. No Partial Redemption

The amount invested in ELSS can only be withdrawn after the end of the three year lock-in period. The other tax saving options like Fixed Deposits do not come with such conditions.

What are the other tax saving options available in India compared to ELSS?

How does one evaluate if they should invest in ELSS mutual fund?

Those individuals who are averse to risk and do not wish to remain invested in ELSS for a longer duration should invest in relatively safer tax saving instruments like Public Provident Fund or Fixed Deposits.

An investor who is willing to take on a moderate amount of risk can invest 60 percent of their savings in ELSS and then the remaining 40 percent in other low-risk tax saving schemes to reduce the overall risk of the portfolio.

It is an ideal tax saving option for those who seek potentially high returns and are willing to undertake a relatively higher amount of risk.

What are the minimum and maximum amounts of investment one can make in ELSS?

The minimum amount of investment varies from scheme to scheme but generally stands at Rs. 5,000 for a lump sum investment and Rs. 500 if going the systematic investment route.

There is no maximum amount of investment one can make in a mutual fund scheme.

If I redeem my funds in ELSS after the 3 year lock-in period, are my gains taxable?

Capital Gains on equity mutual funds can be split between short term and long term. Short Term are those mutual funds who have been held for less than a year and redeemed whereas the long term is those mutual funds who have been held for more than a year and then redeemed.

ELSS falls under the category of long term and gains beyond 1,00,000 are taxable at the rate of 10 percent as per the provisions of the Act.

Long Term Capital Gain on all equity mutual funds including ELSS are tax-free up to Rs. 1,00,000.

Happy Tax Saving Season!