What are ELSS Funds - Tax Benefits and How to Invest?

Equity Linked Savings Schemes or ELSS are tax-saving instruments. It'll help you save on your mutual fund interest earnings. By adding ELSS funds to your portfolio, you are eligible to claim tax rebates under Section 80C of the Income Tax Act, 1961.

The tax-saving mutual funds come under the umbrella of Long Term Capital Gains (LTCG). This means that if your mutual fund income exceeds ₹1 Lakh, the same will be taxed at 10% for that year.

Now that you have gathered a little information about this tax-saving scheme learn more about it below.

What are ELSS Funds?

As you are aware from the above, the full form of ELSS is equity-linked savings scheme. It means the money you put in your ELSS scheme will be invested in equity and equity-related instruments.

So, the ELSS funds carry the same risk as equity mutual funds. What does this mean? It means, your funds will be affected by market risk, volatility risk and concentration risk.

Benefits of Investing in ELSS Funds

Here are the benefits of investing in ELSS funds:

1. Higher Returns
   • ELSS typically invest a significant portion in equity and equity-related instruments. Historically, equity investments have the potential to generate higher returns compared to other tax-saving options.
2. Tax on Returns
   • The returns from ELSS funds are subject to LTCG tax. Gains up to ₹1 lakh in a financial year are tax-free, and gains exceeding this limit are taxed at 10%.
3. Tax Savings
   • Investments in ELSS funds qualify for tax deductions under Section 80C of the Income Tax Act up to a limit of ₹1.5 Lakh per financial year. This helps reduce your taxable income and save on taxes.
4. Major Investment in Equity
   • ELSS funds allocate a significant portion to equities. This provides you with an opportunity to participate in the growth potential of the equity market, which can lead to substantial capital appreciation over the long term.
5. SIP Option Available
   • You can opt for a Systematic Investment Plan (SIP) to invest in ELSS funds. This allows for regular investments, which can help in averaging out the cost of investment and developing disciplined saving habits.
6. Tax Benefits of ELSS Mutual Funds
   • Apart from the tax deduction on the invested amount, the dividends received from ELSS funds are also tax-free.
7. Taxation
   • ELSS funds are subject to favourable tax treatment compared to other investment options. The LTCG tax rate of 10% on gains exceeding ₹1 lakh is lower compared to the tax rates on short-term capital gains and other income.
8. Diversified Portfolio
   • ELSS funds invest in a diversified portfolio of stocks across various sectors and market capitalizations. This diversification helps in mitigating risks and can lead to more stable returns.
9. Just 3 Years of Lock-In
   • ELSS funds have a lock-in period of just three years, the shortest among all tax-saving investment options under Section 80C. This provides greater liquidity and flexibility.

ELSS Mutual Funds Working 

ELSS funds invest your money in shares of companies listed on the stock market. These companies can vary in size and come from different sectors of the economy.

By investing in a mix of large, mid, and small companies from different sectors, ELSS funds spread out the risk. This means that if some stocks don't perform well, others might do better, balancing out the overall performance.

A fund manager, who is an expert in the stock market, selects which stocks to invest in. They conduct thorough research and analysis to pick stocks they believe will perform well.

The primary aim of ELSS funds is to increase the value of your investment over the long term. By holding onto stocks for a longer period, they aim to benefit from the growth potential of these companies. And unlike other funds, investing in ELSS funds provides tax benefits.

How ELSS Funds are Better than Other Tax Saving Schemes?

While ELSS funds offer a compelling option for tax saving, it's important to compare them with other tax saving schemes. Here's a breakdown:

ELSS vs Public Provident Fund (PPF)

• Returns: ELSS come with potentially higher returns due to equity exposure. Whereas PPF offers fixed and guaranteed returns.
• Lock-in Period: ELSS has a 3-year lock-in period, and PPF has 15 years, with a partial withdrawal option after 7 years.
• Risk: ELSS is more risky due to market fluctuations, while PPF is low-risk and ideal for conservative investors.
• Tax Benefit: Similar tax deductions (up to ₹1.5 lakh) under Section 80C.

ELSS vs Fixed Deposits (FDs)

• Returns: Potentially higher returns may be seen in ELSS. Whereas FDs comes with guaranteed returns, typically lower than ELSS.
• Lock-in Period: FD locks in your funds for 5 years, but ELSS only have 3 years of lock-in.
• Risk: In comparison to ELSS, FDs are surely way less risky.
• Tax Benefit: Similar tax deductions (up to ₹1.5 lakh) under Section 80C. Interest earned on FDs exceeding ₹40,000 per year is taxable.

ELSS vs National Pension System (NPS)

• Returns: NPS generates market-linked returns, which may fluctuate. ELSS follows the same scenario but with a different approach. In ELSS, your funds are managed by experts. 
• Lock-in Period: NPS is locked in until retirement with limited withdrawal options. But this won't happen with ELSS, it is locked in for just 3 years.
• Risk: There's a moderate risk with NPS and a high risk with ELSS.
• Tax Benefit: Similar tax deductions (up to ₹1.5 lakh) under Section 80C. NPS offers additional tax deductions of up to ₹50,000 under Section 80CCD(1b).

ELSS vs Unit Linked Insurance Plans (ULIPs)

• Returns: ELSS offers purely investment-based returns, while ULIPs combine insurance and investment, so returns may vary.
• Lock-in Period: The ELSS lock-in period is 3 years. The lock-in period for ULIPs varies, typically 5-10 years.
• Risk: ELSS has only market risk. However, with ULIPs, there is market risk and insurance premium payment risk.
• Tax Benefit: Similar tax deductions (up to ₹1.5 lakh) under Section 80C. The maturity benefits of ULIPs are partially tax-exempt under certain conditions.

List of things you should consider before investing in ELSS

Here are some key things to consider before investing in ELSS:

• ELSS has a lock-in period of 3 years. So, before you invest, ensure it aligns with your goals.
• Consider your risk tolerance because ELSS can be volatile in the short term but may offer high potential later.
• Both lump sum and SIP are allowed, so you can choose your preferred mode.
• Don't just pick an ELSS for tax benefits alone; consider factors like the fund manager's track record, investment style, expense ratio, and portfolio diversification.

By carefully considering these factors, you can make informed decisions about investing in ELSS and use them for your long-term financial goals.

How to Invest in ELSS?

Here's a step-by-step guide to get you started with ELSS:

• Open the INDmoney app and log in (If you have a demat account, you might be able to invest in ELSS through it.)
• Choose your ELSS fund
• Select how long you plan to invest
• Choose your mode of investment: lumpsum or SIP
• Initiate your Investment
• Regularly monitor your investment performance
• Review your portfolio periodically and rebalance, if needed

Conclusion

ELSS funds offer a unique blend of tax-saving benefits and the potential for high returns through equity investments. With a lock-in period of just three years, they provide greater flexibility compared to other tax-saving options. By carefully selecting ELSS funds based on your financial goals and risk tolerance, you can leverage their benefits to grow your wealth and save on taxes.