What is Equity Linked Savings Scheme (ELSS)

Background

Majority of us rush up to our auditors and financial planners during the month of March for tax planning in order to invest up to Rs. 1 lakh that qualifies for tax exemption under section 80C of the Income Tax Act. We end up in paying LIC premium, PPF, NSC, 5 year bank FDs and other traditional tax savings instrument. There is another exciting option available to all of us and that is Equity Linked Savings Scheme (ELSS).

Why look at just another Tax Saving instrument?

The purpose of income tax exemption under section 80C is to promote the habit of savings and long-term investment. However, we generally don't plan for the ideal investment avenue in advance and take last minute decisions, disregarding all the good advice we get about choosing investment products well.

Tax planning is an essential part of your financial planning. Efficient tax planning enables you to reduce your tax liability to the minimum. This is done by legitimately taking advantage of all tax exemptions, deductions rebate and allowances while ensuring that your investments are in line with your long term goals. Mutual Fund ELSS is a damn good tax saving instrument but still it is not used by maximum Indians.

What is ELSS?

An ELSS – Equity Linked Savings Scheme is akin to a Diversified Equity Fund. It is a type of mutual fund that qualifies for tax exemption under section 80 c.  Also unlike those equity funds which require minimum investments of Rs. 5000, one can invest in ELSS with as low as Rs. 500 by means of SIP (Systematic Investment Plan). The returns from ELSS depend on the stock market and hence tend to be volatile, but then they are generally higher than the returns generated from traditional tax saver instruments.

Key characteristics / benefits / features of ELSS

1) One of the important difference between an ELSS and a diversified Equity scheme is that ELSS have a mandatory lock in period of three years. 

2) ELSS gives you a dual advantage of Tax Savings as well as Capital Appreciation since the gains are tax free at redemption. Income/Returns on ELSS schemes (dividend and on redemption) is tax free under EEE (Exempt – Exempt – Exempt) regime of the Income Tax Act. This makes it so unique in the sense that you can invest as much money as you want for gaining tax free returns, and that too linked to equity market.

3) An ELSS is an equity oriented mutual fund scheme in which the majority corpus (about 80-100%) is invested in equities.

4) As the allocation is done in equity which are considered as high return assets, the primary aim of such funds is capital appreciation.

5) As it is linked to equity, it carries higher risk and is not as safe as NSC, PPF etc.

6) It has a 3 year lock in period (which is very less compared to NSC, PPF etc.) post which it is like an open ended mutual fund. 

7) Investors do needs to pay tax on premature withdrawal.

8) ELSS has 2 options: a) Growth Option and b) Dividend Option.

9) There is no upper limit to the money that you can invest in ELSS mutual funds.

Hence, if you wish to save tax while offering your portfolio an extra edge on investing long term, ELSS schemes are designed for you! Make full use of them. ELSS has the lowest lock in period with the maximum possible tax free long term returns as compared to any other investment option.

Cheers

Manoj Arora