Tax planning season is here. Thinking of ways to save taxes this financial year?
Considering investments, you look for opportunities that help you to acquire wealth, regular returns, and save taxes.
Investments in ELSS (Equity Linked Saving Scheme) mutual funds could be one such optimal option that pools money from different investors like you and me and make investments in a variety of stocks, bonds, and other assets to offer you outsized returns.
What are ELSS funds?
ELSS funds are equity funds that invest a major portion of their corpus into equity or equity-related instruments. Since ELSS funds offer a tax deduction on your taxable income, they are also known as tax saving schemes.
Some features include:
- It’s a long-term investment with a lock-in period of three years. It means that an investor can withdraw the funds only after 3 years to avail of tax deduction.
It also allows you to continue your investment or withdraw it after the lock-in period, as such there is no maximum tenure limit. - Some investment schemes allow you to invest with a minimum amount of ₹500, which makes sure that you can start investing without having a sizeable investible corpus.
- The fund works in a diversified manner, which means allocating investments across various financial instruments, industries, and categories.
It aims at balancing risks and returns by investing in different areas that would each react differently to the same event.
ELSS Investments options
- Growth option: With this option, an investor will get the gains only at the time of redemption, and you will not receive such in form of dividends.
- Dividend option: As the name suggests, it offers you the advantage of receiving dividends at regular intervals.
- Dividend Reinvestment option: Under this, you can reinvest the dividends into the funds and continue the same way.
Ways to Invest in ELSS Funds
The lock-in period differs between investments made as lump sums or SIPs.
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Lumpsum: Investing in lumpsum is a plan where you buy units of ELSS in one go. This is one of the common ways to go about investing in ELSS.
Sometimes, investors choose such a plan as they are in rush to save taxes to avail of tax benefits. As a result, they contribute the entire investment in one lumpsum.
Let’s understand with an example, In 2022, Mr. Hiren planned to invest in the ELSS fund and bought 1600 units of ELSS for 2.4 lakhs.
Under this case, the three-year lock-in period ends on 4th February 2025, then after, Hiren can decide whether he wants to withdraw his investment or keep it.
In 2022, the active ELSS schemes provided an average return of 4.34% in a year. Before investing you must analyze the top-performing ELSS funds based on the past three years’ returns.
- SIP: SIP is a method of investing a fixed sum, in a pre-determined interval, in a mutual fund scheme. Another way to invest in ELSS funds is through a Systematic Investment Plan (SIP) or installment options.
Here’s an example of SIP investment, Mr. Hiren wants to invest in ELSS but is not able to do so in large amounts. As a result, he chooses the SIP option and acquires units over a pre-defined interval.
Here’s how the SIP works:
In this case, each installment is treated as a separate investment option, and the lock-in period rule applies to each installment differently from their purchase date.
In the above table, the lock-in period for 50 units bought on 4th Feb 2022 will end on 4th Feb 2025 while the units bought on 4th Feb 2023 will end on 4th Feb 2026. Hence, it is different in all investments. After the lock-in period ends, Hiren can decide whether continue the investment or not.
What are the tax benefits offered by ELSS Mutual Funds?
As per section 80C of the Income Tax Act, you’re eligible to take a deduction of up to ₹150,000 on the amount invested by you in an ELSS scheme in a financial year.
Further, these schemes have a mandatory lock-in period of 3 years. As a result, it is taxable as long-term capital gains (LTCG) when you redeem the units. These gains are not taxable up to the limit of Rs. 1 lakh in a financial year and above that is taxed at 10% of the gains without indexation.
In case, a dividend is received on ELSS mutual fund, then it will be taxable under the income from other sources (IFOS).
Make sure, before investing, you must carefully evaluate your financial goals, risk tolerance, and investment horizon. You can also consult with an investment advisor to help you develop an investment portfolio.
There’s one thing to keep in mind — the returns are subject to market risk.
Read more about ELSS or Equity Linked Savings Scheme: A Complete Guide.