Tax planning plays a crucial role in financial management, and individuals seek efficient avenues to save taxes while maximising returns. Equity Linked Saving Schemes (ELSS) have gained immense popularity as a tax-saving instrument. But the major question many may ask is what is ELSS?
ELSS funds are mutual funds that invest primarily in equities, offering the dual advantage of tax benefits and potentially higher returns. Let’s explore the importance, reasons, and benefits of ELSS investments, followed by a detailed comparison of ELSS with other tax-saving financial products available in India.
Importance of ELSS fund
Potential for wealth creation
As you now know, what is ELSS, it must be clear that as they primarily invest in equities, they offer the potential to generate higher returns over the long period than conventional tax-saving products such as PPF (public provident fund) or tax-saver FDs (fixed deposits). For instance, suppose an investor invests Rs. 1 lakh in an ELSS fund with an average annual return of 12% over 10 years. The investment can grow to approximately Rs. 3.10 lakhs, significantly outperforming other instruments.
ELSS funds provide tax benefits under Section 80C of the Income Tax Act, allowing investors to claim deductions of up to Rs. 1.5 lakh from their taxable income. Example: If an individual with a taxable income of Rs. 10 lakh invests Rs. 1.5 lakh in ELSS, their taxable income reduces to Rs. 8.5 lakh.
Features of ELSS fund
ELSS funds invest in a diversified portfolio of stocks across various sectors and market capitalisations, reducing the risk associated with investing in a single stock or sector. Example: An ELSS fund may hold stocks from sectors like banking, information technology, pharmaceuticals, etc., providing exposure to different segments of the market.
ELSS funds offer flexibility in terms of investment amounts. Investors can start with as low as Rs. 500 and subsequently make additional investments systematically. Example: An individual can choose to invest Rs. 5,000 per month in an ELSS fund through a systematic investment plan (SIP).
ELSS funds have a mandatory lock-in period of 3 years, which is the shortest among all tax-saving instruments. Example: If an investor starts an ELSS investment on January 1, 2023, they can redeem the units or switch to another scheme only after January 1, 2026.
ELSS funds are managed by experienced fund managers who aim to optimise returns by selecting the right stocks and managing the portfolio actively. Example: A skilled fund manager may identify undervalued stocks and capitalise on market opportunities to generate higher returns for the investors.
ELSS funds also offer a dividend option where investors can receive periodic dividends declared by the fund. For instance, a retail investor who opts for the dividend option might get dividends from ELSS semi-annually or annually, based on the fund’s declaration.
ELSS endows the potential for capital growth as they primarily invest in equities and equity-linked instruments, which often endow long-term appreciation in capital. For instance, if a retail investor holds ELSS fund units for a longer period, they can make the most out of the growth potential endowed by equities and avail a rise in investment value.
Systematic withdrawal plan (SWP)
Post the mandatory lock-in period of three years, retail investors can set up an SWP (systematic withdrawal plan) for receiving constant payouts from ELSS. For instance, if a retail investor wants to get a fixed amount every month post the lock-in period, then they can choose the SWP option for the systematic flow of cash.
Transparency in reporting
ELSS offers constant updates on the scheme’s performance, portfolio holdings, as well as financial statements, providing great transparency to retail investors. For instance, retail investors can get hold of the fund’s fact sheet that reveals the asset allocation, performance and the major metrics concerning ELSS.
SIP with ELSS
ELSS offers high convenience in investment via SIP (systematic investment plan), allowing retail investors to put a fixed amount of funds at periodic intervals. For instance, a retail investor can begin with a SIP investment of Rs 2,000 every month in the preferred ELSS scheme, ensuring disciplined investments across the year.
STP or systematic transfer plan
ELSS funds also provide the facility of a systematic transfer plan, allowing investors to transfer a fixed amount from one scheme to another. Example: If an investor wants to gradually shift their investments from an ELSS fund to a balanced fund, they can set up an STP for a predetermined amount and duration.
Capital gains tax
While ELSS funds offer tax benefits, investors should be aware of the long-term capital gains tax. Gains above Rs. 1 lakh in a financial year are subject to a 10% tax. Example: If an investor earns a long-term capital gain of Rs. 2 lakhs from an ELSS investment, Rs. 10,000 (10% of the gain above Rs. 1 lakh) would be applicable as tax.
ELSS vs. other tax savings instruments – Comparative analysis
ELSS vs. Fixed Deposits (FD)
ELSS funds have the potential to outperform fixed deposits due to the exposure to equity markets, which generally deliver higher returns over the long term. Example: An investor looking for tax-saving options can consider ELSS funds over fixed deposits to potentially earn higher returns and enjoy the tax benefits.
ELSS vs. NPS tax benefit
ELSS funds have an edge over the National Pension Scheme (NPS) in terms of tax benefits. While both provide deductions under Section 80C, ELSS offers greater flexibility and potential for higher returns. However, an additional NPS tax benefit of Rs 50,000 over and above Section 80 C deduction, encourages investors to invest in both options to save tax. For instance, an individual can choose to invest in ELSS funds as they offer the dual advantage of tax savings and higher growth potential compared to NPS. However, to save a higher tax of over Rs 1.50 lakh, NPS is a preferable option owing to the additional deduction of Rs 50,000 allowed under Section 80 CCD (1b).
ELSS vs. ULIP
ELSS funds and Unit Linked Insurance Plans (ULIPs) differ in terms of investment options and charges. ELSS funds are pure investment instruments, while ULIPs combine investment and insurance components. Example: Investors seeking pure investment opportunities with tax benefits can opt for ELSS funds, whereas those looking for an investment-cum-insurance solution can consider ULIPs.
ELSS vs. PPF
ELSS funds offer the advantage of liquidity and potentially higher returns compared to the Public Provident Fund (PPF), which has a longer lock-in period and lower interest rates. Example: Individuals with a long-term investment horizon and higher risk appetite may choose ELSS funds for potential wealth creation, whereas risk-averse investors may prefer the stability of PPF.
In conclusion, ELSS funds offer a unique combination of tax benefits, the potential for wealth creation, and a range of features that make them an attractive tax-saving instrument in India. While comparing ELSS with other tax-saving financial products, investors should consider their risk profile, investment horizon, and financial goals to make an informed choice that aligns with their requirements.