Maximize Tax Savings with ELSS: Your Guide to Equity Linked Savings Scheme Benefits

Investing is a crucial aspect of financial planning, and for many, saving on taxes is equally important. Equity Linked Savings Schemes (ELSS) offer a unique combination of tax benefits and wealth creation potential, making them a popular choice among investors in India.

In this article, we will delve into the nitty-gritty of ELSS, exploring what it is, its benefits, and some key considerations when investing in ELSS and tax-saving mutual funds. 

What are ELSS tax saving funds?

ELSS stands for "Equity Linked Savings Scheme." It is a type of mutual fund investment scheme that is available in India. ELSS funds primarily invest in equities (stocks) and equity-related instruments.

As per the guidelines laid out by the Securities and Exchange Board of India (SEBI), these funds must invest at least 80% of their assets in equities. The remaining portion may be invested in debt securities or cash to manage risks and provide some stability.

Unlike other tax-saving instruments like the Public Provident Fund (PPF) or National Savings Certificate (NSC), ELSS has a shorter lock-in period of three years. This means that once an investor puts money into an ELSS fund, they cannot withdraw it for three years from the date of investment.

After the lock-in period ends, investors can either redeem their investments in partial or full or stay invested in the fund based on their financial goals and market conditions.

Benefits of ELSS tax-saving funds

ELSS and tax-saving is also an investment opportunity. Here's how ELSS benefits the investor:

Shorter Lock-in Period

ELSS has the shortest lock-in period compared to options like PPF and NSC. This allows investors to access their funds after just three years.

Corpus Diversification

ELSS invests in a diversified portfolio of stocks across various sectors, reducing stock volatility and risk.

Potential for Higher Returns

As ELSS invests a significant portion of its corpus in equities that has the potential to generate higher returns as compared to traditional options.

Fund Management

ELSS funds are managed by experienced and skilled fund managers who make investment decisions based on in-depth research and analysis.

Is ELSS tax-free?

ELSS and tax savings benefits can be claimed under Section 80C of the Income Tax Act. However, ELSS is not entirely tax-free. Investments made in ELSS funds are eligible for a deduction up to a maximum limit of Rs. 1.5 lakh per financial year.

While ELSS investments are subject to a mandatory lock-in period of three years, gains realized after the lock-in period may attract capital gains tax.

If you hold your ELSS units for more than three years, the gains will be considered as long-term capital gains (LTCG) and are currently taxed at a rate of 10% on gains exceeding Rs. 1 Lakh in a financial year.

Before three years, gains are treated as short-term capital gains (STCG) and taxed at a rate of 15%.

How much should I invest in ELSS to save tax?

The maximum amount you can invest in ELSS to save tax under Section 80C of the Income Tax Act is Rs. 1.5 Lakh per financial year. It means you can claim a deduction of up to Rs. 1.5 Lakh from your total taxable income by investing in ELSS funds.

If you invest Rs. 1.5 Lakh in ELSS, you can effectively reduce your taxable income by the same amount, resulting in potential tax savings depending on your income tax slab.

Here's a quick example to illustrate how it works:

Let's assume your total taxable income for the financial year is Rs. 7 Lakh, and you invest the maximum Rs. 1.5 lakh in ELSS.

Taxable Income: Rs. 7,00,000

ELSS Investment: Rs. 1,50,000

Taxable Income after deduction: Rs. 7,00,000 - Rs. 1,50,000 = Rs. 5,50,000

Based on the income tax slab rates for the relevant financial year, you can now calculate the tax payable on the reduced taxable income of Rs. 5,50,000.

Under the Old Tax Regime, the taxable income comes under the 20% tax bracket. Under the New Tax Regime, the taxable income comes under the 10% bracket.

How to invest in ELSS?

To invest in Equity Linked Savings Scheme (ELSS) funds, you can follow these steps:

Step 1:

Reach out to your bank and mention your interest in investing in ELSS. Your bank will connect you with the right person to advise or guide you to make investments online. Alternatively, you can also start investing via mobile apps. ET Money, Groww, and Paytm Money are some of the popular choices.

Step 2:

You'll need to complete the KYC process, which involves submitting identity and address proof documents, as mandated by regulatory requirements. On most mobile apps, the process is completely paperless. You are only required to submit clicked photos of documents and upload them.

Step 3:

Before making any investment, decide if you want to invest through a lump sum or SIPs. Investing through a lump sum means you make one investment, typically a higher amount, and lock in for 3 years. You can choose to not make any more investments for that financial year if the investment aligns with your financial goals and tax deduction objectives.

SIPs or Systematic Investment Plan enables you to invest a certain amount on a monthly basis.

Note: When opting for ELSS and SIP, each individual SIP is locked-in for three years respectively.

Step 4:

Once decided on the mode of investment from lump sum or SIPs, you'll need to make the payment using methods provided by the mutual fund company, such as online banking, checks, or other payment options.

If you're opting for SIP, you'll set up an automatic deduction from your bank account as per your chosen SIP frequency (monthly, quarterly, etc.).

Step 5:

Keep track of your ELSS investment, monitor its performance periodically, and review your investment strategy as needed. ELSS funds have a lock-in period of three years, so you won't be able to redeem your investment before this period is over.

Step 6:

Ensure that you keep a record of your investment-related documents, such as the investment acknowledgment, account statements, and any tax-related documents for claiming deductions under Section 80C.

Key considerations when investing in ELSS

It's important to note that while ELSS funds offer tax benefits, they are subject to market risks, and the value of your investment can fluctuate. Before making any investment decisions, it's advisable to consult with a financial advisor to ensure that your investment choices align with your financial goals and risk tolerance.

Risk Factor

ELSS carries a higher risk compared to traditional fixed-income tax-saving instruments due to its exposure to the equity market. While the potential for higher returns is enticing, investors must be prepared for short-term market fluctuations.

Investment Horizon

ELSS is ideally considered as a long-term investment option, aligning with the investor's financial goals. Investing for the long term allows investors to ride out market volatility and benefit from potential wealth creation.

Diversification

While ELSS funds diversify their portfolio, it is advisable for investors not to put all their tax-saving investments into a single fund. Diversifying across multiple funds can help spread risk further.

Past Performance

While past performance doesn't guarantee future results, assessing the historical performance of an ELSS fund and comparing it with its benchmark and peer group before investing is essential.

Expense Ratio

ELSS funds have an expense ratio that covers the fund's management charges. Investors should compare expense ratios across funds to ensure they are not paying higher charges, which can impact overall returns.

5-star rated ELSS Mutual Funds

We can provide you with a list of some ELSS funds that were highly rated by various agencies and research firms. However, please note that the performance and ratings of mutual funds can change over time, and it's essential to do your own research or consult with a financial advisor for the most up-to-date information before making any investment decisions.

Here are some ELSS funds that were well-regarded:

Aditya Birla Sun Life Tax Relief 96

Axis Long Term Equity FundMirae Asset Tax Saver FundICICI Prudential Long Term Equity Fund (Tax Saving) DSP Tax Saver FundSBI Magnum Tax Gain Fund Kotak Tax Saver Fund Canara Robeco Equity Tax SaverHDFC Tax Saver FundIDFC Tax Advantage (ELSS) Fund

Please note that the "star ratings" might be from rating agencies like Morningstar, CRISIL, or Value Research. These agencies assess mutual funds based on various parameters, including historical performance, risk-adjusted returns, and other factors. It's important to review the latest ratings, performance, and other relevant information before making an investment decision.

Mutual fund investments are subject to market risks, and past performance is not necessarily indicative of future results. Make sure to consider your investment goals, risk tolerance, and do thorough research before investing in any fund.

Final thoughts on ELSS and tax savings

ELSS is a tax-saving investment option that offers the potential for higher returns through exposure to the equity market. With its shorter lock-in period, diversification benefits, and tax-saving advantages, ELSS remains a popular choice for investors looking to grow their wealth while saving on taxes.

However, like all investments, ELSS comes with its risks, and investors must carefully assess their risk tolerance, investment horizon, and financial goals before investing.

Seeking advice from a financial advisor can also be beneficial in constructing a well-balanced investment portfolio that aligns with individual needs and aspirations.

Note: If you enjoyed learning about ELSS, you may also like reading about Sovereign Gold Bonds Scheme or FDs and tax-saving.