An Essential Guide to Tax Saving Mutual Funds – ELSS: Whenever you research how to save taxes in India, you can easily find the experts mentioning to invest in tax saving mutual funds or ELSS. However, for beginners, getting started with ELSS investment might be a little confusing.
In this post, we are going to cover everything regarding tax saving mutual funds. By the end of this post, you’ll be able to clearly understand why exactly is an ELSS and how it works.
So, if you are a newbie and find it challenging to get started with tax saving mutual funds in India, then please read this article until the very end. It will definitely help you to demystify the majority of the questions that you might have regarding ELSS. Let’s get started.
1. What is Equity linked saving schemes (ELSS)?
An ELSS (Equity Linked Savings Scheme) Mutual Fund is a variety of Equity Mutual Fund which allows individuals and HUFs to avail Income Tax deduction from their Total Income for an Assessment Year subject to a maximum limit of Rs.1.5 lakhs u/s 80C of the Income Tax Act, 1961.
ELSS mutual fund is an Equity oriented fund which is having a lock-in period of 3 years. The said duration is counted from the respective allotment date of the unit(s).
Like any other type of Equity Mutual Fund, ELSS comes with both growth and dividend options as well.
Investment in an ELSS scheme can either be made in a lump-sum or through a Systematic Investment Plan (SIP). Investments made in a Financial Year (Previous Year) up to ₹1.5 lakhs can be claimed for tax deduction under the said Act.
Till the Financial Year 2017-18, no tax on income from Long-term capital has been charged from an Assessee on redemption of the unit(s) of an ELSS. As per the Budget (Finance Act) 2018, Long-term capital gain over ₹1 lakh is to be taxed @ 10% by the Government of India.
2. Types of ELSS
ELSS comes in two varieties. The first category is the dividend scheme and the second type is the growth scheme.
In the case of former, when the mutual fund announces a dividend, the unitholders earn income in the form of a dividend on the units held by them. Such dividends can either be withdrawn or reinvested by the unitholders.
Another part of ELSS with dividend feature is that the dividend earned is eligible for tax benefits. Moreover, the dividend earned by the unitholder is not subjected to any lock-in period, i.e. it can be withdrawn any time.
A similar provision is not applicable to the growth schemes.
3. What are the features of Tax Saving Mutual Funds?
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- In order to avail the benefit of the tax deduction, an Assessee can make an investment in an ELSS Mutual Fund for as low as Rs. 500. There is no upper limit of investing in ELSS, unlike PPF and NSC, but as said earlier one would only get tax deduction u/s 80C to the maximum of Rs. 1.5 lakh.
- Investment in an ELSS scheme is, of course, meant for a long duration as it comes with a lock-in-period of 3 years.
- Irrespective of the short lock-in period of ELSS funds, the later have time and again yielded substantially higher returns in comparison to NSC, PPF, ULIP, etc.
- ELSS is an equity oriented mutual fund wherein the underlying portfolio majorly consists of equity investments in publically listed companies having strong business models. Being equity oriented mutual fund, it is subjected to market risks.
- Tax saving mutual funds or ELSS are mostly open-ended.
- Like any other mutual fund, an investor of ELSS can also make another person as his/her nominee.
- Like most of the equity funds, many ELSS funds also come with entry and exit loads.
- Many investors prefer investing in ELSS funds through the SIP route. It ensures rupee cost averaging that significantly cuts volatility in the stock market.
4. What are the benefits of investing in an ELSS?
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Here are a few of the distinguishing benefits of investing in ELSS:
- As discussed earlier, a taxpayer can enjoy the benefit of deduction from his/her taxable income (for a maximum of Rs.1.5 lakh).
- We all know that Mutual Fund investments are subject to market risks i.e. systematic risks. Market risks can’t be eliminated but the fund manager invests the funds of investors in diversified equities which eliminate the unsystematic risks.
- An investor may opt for not withdrawing the investment at all after the end of the 3 years lock-in-period. Holding on the units will result in the growth of the investment and will subsequently yield handsome inflation risk-adjusted return for the investor.
- As said earlier, the investor can withdraw any dividend earned as no restriction is there on its withdrawal during the lock-in-period. The restriction of withdrawal is there only in respect of the investment.
- ELSS, being an open-ended mutual fund, allows anyone to invest in the same at any time during the year.
- One can find popular tax saving avenues like ULIP, NPS, and PPF which offer lock-in period ranging from 6 to 15 years. But, investing in ELSS will reduce the lock-in-period significantly to 3 years only.
- In case an investor of ELSS is not having knowledge of the market, he/she can be rest assured that his/her funds will be managed by a qualified fund manager.
- It is not necessary that one has to invest in ELSS for only availing tax benefits. ELSS can also be considered as a long-term wealth generation tool. As the lock-in-period is 3 years, one can even think of investing in ELSS for meeting any future financial goal.
5. How is the Capital Gain from an ELSS Fund taxed?
If an investor sells his/her units of an equity mutual fund after a year, tax on long-term capital gains (LTCG) will be applicable.
Up to 31st March 2018 tax charged on the long-term capital gain was nil. But, as per the Union Budget 2018, tax on LTCG of stocks and equity funds were re-introduced. If the long-term capital gain exceeds Rs.1 lakh from the redemption of an equity fund, then tax @10% will be charged on such LTCG.
Again, in the said budget it said that if investors sell their equity mutual funds within a year, they will be required to pay short-term capital gains tax @15% on their returns. The provision regarding short-term capital gain (STCG) tax was there in the Finance Act 2017 as well.
ELSS funds as said earlier, are having a lock-in period for 3 years. So, the gain on an ELSS fund by default comes under the long-term capital gain tax.
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6. How to choose the right ELSS fund?
Following key points should be considered by someone who is looking to invest in an ELSS fund:
Looking into the past performance: Past performance does not guarantee future performance of a mutual fund scheme. Looking at historical returns is the initial step of evaluating a scheme. It helps in evaluating the performance of the fund managers over the years.
Age of an ELSS Fund: An ELSS Fund has been in the market for 5 years or more is generally considered ideal for new investors. This is because they generally represent reputed AMCs and have good track records.
Risk of ELSS: Different ELSS schemes come with different risks. An investor should select a specific ELSS Fund based on his/her risk appetite.
Looking at the Expense Ratio: The Expense Ratio refers to the percentage of the fund which an asset management company charges from the unitholders. This is the charge for meeting the cost of operations of the fund.
Assets Under Management (AUM): This is the amount of money which is being managed by a mutual fund scheme. Various types of ELSS Funds have different ideal sizes for AUM.
Checking the Rating of ELSS Fund: Ratings of the ELSS Funds published in a reputed online platform helps a prospective investor to know which fund is the best.
7. The last few words on ELSS Mutual Funds
With the rise in the equity market over the years, the investors have gained interest in ELSS mutual funds as an income tax saving instrument. ELSS is a category of equity mutual fund that is created by the government to encourage people at large to participate in the equity market of India.
As ELSS funds come with the benefit of the tax deduction, middle-aged people feel interested to invest in the major part of their savings in the Indian equity market.
There is no doubt in saying that investing in an ELSS scheme is certainly not risk-free. Even though the NAV graph of an ELSS scheme is not free from frequent ups and downs, the growth of the fund never falls below other tax saving alternatives like PPF and ULIP.
But, owing to a fact of scope for higher returns at a minimum lock-in period, Equity Linked Saving Schemes have emerged as the most demanding tax saving option today.