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What is ELSS: Meaning, Benefits, and How to Invest

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What is ELSS: Meaning, Benefits, and How to Invest
December 14, 2023

Table of Content

 

Mutual funds these days have become a popular choice of investment plan among investors who prefer a professionally managed financial mechanism that can fetch them bigger returns from the market. However, with growing wealth comes a higher need for tax savings to enjoy better returns from the investment. This is where the Equity Linked Savings Scheme (ELSS) can do wonders. More precisely, this is the only mutual fund scheme that comes with tax benefits.

Are you someone looking to invest in market-linked funds to grow your wealth, yet stay cautious about tax savings as you move ahead on your investment path? ELSS can be an answer to your searches as it combines the scope of wealth generation with tax deductions. But of course, before you choose to invest in it, make sure you have clarity of what is ELSS, its features, benefits and how the fund operates to minimize the risks of losing the capital. This in turn will ensure a satisfying investment journey. 

Why are ELSS funds the most advantageous for tax savings?

While you learn what is ELSS fund, it’s crucial to understand why it is considered the most advantageous for tax savings. The following are the reasons behind this consideration. 

  • When it comes to tax-saving mutual funds, ELSS is the only available option in the market that allows you to accumulate wealth while saving taxes. 
  • It helps you earn higher returns, and reduce the income tax burden by offering deductions, yet in the lowest possible time. This is because ELSS investment options come with a lock-in period of just three years, the shortest among all tax savings interest.
  • ELSS mutual funds offer you the highest possible returns under the provisions of section 80C of the Income Tax Act, 1961. It allows you to enjoy deductions of up to Rs 1.5 lakh per year and save up to Rs 46,800. 

What is an ELSS fund?

As the name suggests, ELSS is an equity-based mutual fund scheme. A stock fund by nature, ELSS invests your money majorly in equities or related instruments that generate higher returns over a longer tenure, yet with the shortest possible lock-in period of just 3 years. Typically, it contains equities as a minimum of 80% of the portfolio that couples high returns with high risks and the rest being majorly fixed income assets to offset the market fluctuations. It is also the only mutual fund that enables wealth creation with tax benefits. So, if you are a risk-taker, investing in an ELSS fund can turn out to be a good choice, helping you to grow your wealth while saving taxes. It can be a useful tax saving investment as per the applicable income tax slab rate for you.

What are the features of ELSS Mutual Funds?

Knowing what is ELSS mutual fund is not all. Understanding the features can help you make an informed choice of investment. Here’s a list.

  • At least 80% of the ELSS corpus is invested in equities and related financial instruments. 
  • The portfolio contains a diverse choice of equities across market capitalizations, sectors and specific targets. 
  • While there’s a 3-year lock-in period, there’s no upper cap for the investment tenure. 
  • Any amount can be invested in ELSS schemes, but tax deductions are available for Rs 1.5 lakh per annum under section 80C of the Income Tax Act, 1961. 
  • The income earned through ELSS is taxable under the prevailing tax laws. 

What are the tax benefits offered by ELSS Mutual Funds?

As the only mutual fund scheme with tax benefits, ELSS mutual funds offer deductions in your taxable income under the provisions of the Income Tax Act, 1961. The benefits are as follows:

  • Tax exemptions are available for investments up to Rs 1.5 lakha year under section 80C of the Income Tax Act, 1961. However, this total deduction is available for cumulative investments in all instruments that fall in this category like insurance, ELSS, Public Provident Fund (PPF), National Pension System (NPS) etc.   
  • ELSS provides you with the highest possible returns under 80C as you get to save up to Rs 46,800 on taxes. 
  • With a lock-in period of 3 years, there is no short-term gain in ELSS. It offers you long-term capital gains which are exempted from taxes up to Rs 1 lakh a year. Beyond this limit without indexation, a 10% tax is payable for the LCTG earned from the ELSS investment options.

How to invest in ELSS?

Investing in ELSS follows a similar process of investment in mutual funds. You can easily check, compare and pick a fund and make an online payment through an Online Investment Services Account. There is no upper limit for ELSS investments, though tax exemptions are available till the point of Rs 1.5 lakh per year. Invest in ELSS on a regular schedule via a systematic investment plan (SIP) or in a lump sum if you have a fund ready. However, SIP offers you reduced risk, enabling you to invest as little as Rs 500 in a regular schedule and yet enjoy tax benefits.

Who should invest in the ELSS fund?

An ELSS fund allows you to enjoy tax benefits while growing your money. Thus, if an individual is looking to accumulate wealth through market returns and save on taxes alongside, they should invest in an ELSS fund. Based on the features of the fund, the following are the people for whom ELSS investment can be an ideal choice. 

  • Those who wish to invest a small amount on a regular schedule to reduce the risk of losing capital.
  • Those who are eyeing higher returns by investing for a long period.
  • Those who want to invest in a diversified portfolio to offset the losses with capital gains.
  • Those who don’t want to lose out on tax benefits despite investing in mutual funds. 

Factors to consider before investing in ELSS funds

Before you take the final call to invest in an ELSS fund, here’s a checklist of factors that you need to consider. 

  • The financial roadmap

    Alongside the tax benefits, there’s more to your ELSS investment. Being an equity-based scheme, these funds generate better returns when you stay invested for a longer period beyond the 3-year lock-in period. Moreover, instead of lump sum investments, it’s a safer bet to invest small amounts in a regular schedule through a SIP. Keep these things in mind and create a financial roadmap for yourself to make the most of your ELSS investment. 

  • The risk appetite

    How far can you take risks in your investment? This is a crucial factor if you plan to invest in an ELSS fund. Having a portfolio of 80% equities and related instruments, ELSS funds come with higher risks and higher returns. So, unless you have a high-risk appetite, these funds do not offer a comfortable investment option for you. 

  • The investment strategy

    A stock fund by nature, ELSS majorly relies on equities to fetch higher returns for its shareholders in the long run, but at higher risk. Hence to protect the capital, an appropriate mix of multiple asset classes as well as a percentage of fixed-income instruments are essential in the portfolio. This will secure the capital when the equity market takes a downturn. Thus, it is crucial to have a strong investment strategy in place to optimize the returns from an ELSS fund. 

Why should you invest in ELSS tax-saving mutual funds?

A tax-saving financial instrument with wealth creation opportunities through an equity-based fund, ELSS is increasingly becoming a popular choice among investors. But it’s important to know why you should invest in ELSS funds before you take your pick. Here’s a set of benefits that make ELSS investment a worthy choice. 

  • The portfolio is chosen by experienced and expert investment professionals.
  • A diverse portfolio helps in lowering the overall risk of losing money.
  • You can invest a small amount to get access to a wide set of equities and related instruments. In most schemes, you can start investing in an amount as low as Rs 500.
  • ELSS is the only mutual fund entitled to tax deductions. It helps you to accumulate wealth while saving on taxes. 
  • ELSS funds offer any time withdrawal making liquidity an easy deal.
  • You can stay updated on your fund’s performance through constant tracking and monitoring. 

Tax implications on ELSS

Following are the tax benefits you can enjoy through your ELSS investment. 

  • Investments in ELSS up to Rs 1.5 lakh a year are exempted from income tax under section 80C of the Income Tax Act, 1961. Claiming a deduction, you can save up to Rs 46,800 per year. 
  • Post the lock-in period of 3 years, ELSS funds can fetch higher returns in the long run. This capital gain is tax-free up to the limit of Rs 1 lakh. Beyond this threshold, a 10% tax is payable for the long-term capital gains. 

What should be the mode— SIP or lumpsum?

ELSS funds allow you to invest in two ways— either in a lump sum or in small amounts for a regular schedule through SIP. However, SIP is a preferred choice for many as it allows you to invest in small amounts, reducing the overall risk of losing capital. Moreover, affording a small amount for the ELSS fund every month doesn’t tug at your pocket.

ELSS vs other tax-saving instruments

Known to be the only mutual fund with tax benefits, where does ELSS stand in comparison with other tax-saving instruments? Look at the table below to get a clear understanding. 

Investment

Lock-in period

Returns

Tax on returns

5-year FD

5 years

4-6%

Yes

PPF

15 years

7-8%

No

NPS

Up to retirement

8-10%

Partially taxable

NSC

5 years

7-8%

Yes

ELSS

3 years

15-18%

Partially taxable

Other investment options to save tax

If you are looking to build wealth and as well as secure your financial future with a life cover then you can consider ULIPs as an investment option. ULIPs provide tax benefits on the investment amount. The tax benefits under Section 80C of the Income Tax Act of 1961 allow you to invest and grow your money while minimising your tax burden.

In ULIP Plan, the investment risks in the investment portfolio is borne by the policyholder.

Conclusion

By now, you have surely gained sufficient knowledge to invest in an ELSS fund. However, carefully consider your budget, risk appetite and financial goals to ensure an optimized return from your investment. Once they align with your investment, earning high returns from your ELSS fund won’t be that difficult. 

Frequently asked questions on ELSS

Q. What is ELSS and how it works? 

Ans. As suggested by the name itself, ELSS is an equity-major fund that earns high returns at high risk. Moreover, it’s the only mutual fund that offers tax benefits under section 80C of the Income Tax Act, 1961. This fund allocates a minimum of 80% of the corpus into equities and related instruments and the rest in fixed-income assets. It thus reduces risk and protects your capital while helping you save up to Rs 46,800 a year through tax rebates. With the shortest lock-in period of 3 years under 80C, it can fetch higher returns in the long run. 

Q. What is the lock-in period in ELSS Mutual Funds?

Ans. The lock-in period in the ELSS mutual fund is 3 years. This is the shortest lock-in period under the provisions of section 80C of the Income Tax Act, 1961. 

Q. Can I withdraw all money from ELSS after 3 years?

Ans. Yes, if you invest the total amount in a lump sum. Thus, you invest only once and the lock-in period of 3 years gets over on the same day for all the units of the corpus. Post that day, you are allowed to withdraw all the money from ELSS. 

Q. Can I redeem the ELSS mutual fund anytime?

Ans. No, the ELSS mutual fund can’t be redeemed at any random time. These funds have a lock-in period of 3 years, and you have to wait for it to get over before you can redeem your fund.

Q. How to calculate ELSS returns?

Ans. Calculate ELSS returns in these easy and simple steps:

  • Log on to the ELSS calculator on your chosen fund’s website.
  • Specify the nature of investment as SIP or lump sum.
  • Enter the amount of investment and frequency of SIP (if chosen).
  • Mention the expected rate of returns per annum. 
  • Lastly, choose the investment tenure. 
  • Based on the furnished details, the ELSS calculator will estimate the amount of wealth accumulated at the end of the investment period.

ARN - ED/12/23/6739

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Francis Rodrigues Francis Rodrigues

Francis Rodrigues has a decade long experience in the insurance sector, and as SVP, E-Commerce and Digital Marketing, HDFC Life, manages the online sales channel, as well as digital and performance marketing. He has had hands-on experience in setting up sales channels and functional teams from scratch over a career spanning 2 decades.

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Vishal Subharwal Vishal Subharwal

Vishal Subharwal heads the Strategy, Marketing, E-Commerce, Digital Business & Sustainability initiatives at HDFC Life. He is responsible for crafting and ensuring successful implementation of the overall organisation strategy.

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