Equity Linked Savings Scheme (ELSS) is a type of mutual fund scheme that provides dual benefits of saving taxes along with generating reasonable returns. This blog elaborates about how these funds work, its features, tax benefits, and who should invest.
How Do ELSS Mutual Funds Work?
As per guidelines of the Securities & Exchange Board of India (SEBI), at least 80% of the assets of ELSS mutual funds is invested in equity. However, a part of the underlying assets is invested in low risk fixed-income securities to balance out the portfolio. One of the main features of this type of mutual fund is its tax savings aspect.
What Are the Features & Benefits of ELSS Mutual Funds?
Certain aspects of ELSS mutual funds that can benefit you are:
-
Lock-in Period
ELSS funds come with a lock-in period of 3 years. This is the lowest lock-in period available across all categories of tax savings instruments. Investors can redeem the units just after 3 years of investment.
-
Tax Savings
ELSS is the only type of mutual fund which helps you save on taxes. Investments up to ₹1.5 lakh in such schemes can be claimed for deductions from total income under section 80C of the Income Tax Act, 1961. Therefore, apart from providing decent returns, it also serves the purpose of efficient tax planning.
-
Return Potential
Although these funds have a high risk quotient, the return potential is also equally high. This is because equities and related instruments are high growth investment options and can provide significant capital appreciation over time.
-
Mode of Investment
Just like other mutual funds, you can invest in ELSS funds via the lump sum methods or through a Systematic Investment Plan (SIP). While the former involves making a one-time payment, the latter entails making periodic payments. SIP allows investors to take advantage of rupee cost averaging, thereby bringing down the effective cost of investment.
How Are ELSS Mutual Funds Taxed?
As the majority of asset allocation in these funds is linked to equity and related instruments, the tax treatment of this fund is similar to the taxation of equity mutual funds. The capital gains accrued from the sale of these funds qualify for capital gains tax.
Short term capital gains (STCG) tax arises if the units of a mutual fund are held for less than a year. This is not applicable in case of ELLS funds, as they have a minimum lock-in period of 3 years.
Long-term capital gains (LTCG) from ELSS funds are taxed at a flat rate of 10% with no indexation benefits. Moreover, annual LTCG up to 1 lakh are tax-exempt.
Most importantly, ELSS funds provide tax relaxation. Section 80C of the Income Tax Act allows deductions from total income for ELSS investments of up to ₹1.5 lakh in a year. This helps you to reduce your gross tax liability.
Who Should Invest in ELSS Funds?
ELSS mutual funds invest a majority of their portfolio in equity or other equity-linked instruments. As a result, it is a high-risk venture and may not be a preferable option among conservative or risk-averse investors. High risk in these funds is due to the inherently volatile nature of equities.
Also, these mutual funds come with a lock-in period of 3 years. It means you cannot redeem the units for at least 3 years from the date of allotment. If you have a medium to long-term investment horizon, ELSS funds might be the ideal investment choice for you. If you wish to have access to highly liquid funds, consider avoiding these funds.
Things to Consider Before Investing in ELSS Funds
These are some factors that you should keep in mind while investing in an ELSS fund:
-
Investment Objective
You must assess whether this fund will be able to fulfil your investment objectives. Consider the mandatory lock-in period and the tax deduction amount before going ahead with any investment decision.
-
Past Performance of the Fund House
Past performance of the manager or fund house is an important factor that you cannot miss. You should analyse their previous performance against targets set and decide whether investing in the particular fund is beneficial or not.
Final Word
ELSS mutual funds are an efficient investment alternative as they possess the potential of generating higher returns compared to traditional tax saving instruments. Although, investors should consider the risk associated with equity investment and think about their investment objectives carefully before taking a decision.