What is an Equity Linked Savings Scheme (ELSS)?
An Equity Linked Savings Scheme, or ELSS, is a special category of mutual fund. Like other mutual funds, it pools money from various investors and invests it in the stock market. Specifically, ELSS funds are mandated to invest at least 80% of their assets
in equities or stock market-related instruments. What makes them unique is their tax-saving feature. An investment in ELSS is eligible for a tax deduction under Section 80C of the Income Tax Act, 1961, making it a popular choice for salaried individuals and taxpayers looking to reduce their tax liability. This benefit is available to those who opt for the old tax regime.
The Dual Benefit: Tax Savings and Capital Growth
The primary appeal of ELSS is its two-in-one advantage. Firstly, you can claim a deduction of up to ₹1.5 lakh from your taxable income for the amount you invest in a financial year under Section 80C. For someone in the highest tax bracket, this can lead to significant tax savings. Secondly, since the money is invested in the equity market, it has the potential to generate higher, inflation-beating returns over the long term compared to traditional fixed-income products. This combination allows you to not only save tax but also build a substantial corpus for your future financial goals.
The Shortest Lock-in Period in its Class
Every tax-saving investment under Section 80C comes with a mandatory lock-in period, during which you cannot withdraw your money. ELSS funds feature a lock-in period of just three years from the date of investment. This is the shortest lock-in period among all popular 80C options. For comparison, the Public Provident Fund (PPF) has a lock-in of 15 years, and National Savings Certificates (NSC) have a five-year lock-in. This shorter duration provides greater flexibility and quicker access to your funds after the mandatory period. It is important to note that after three years, your money is not automatically redeemed; it remains invested, continuing to grow until you decide to withdraw it.
How to Invest: SIP vs. Lumpsum
There are two primary ways to invest in an ELSS fund. You can either invest a single, large amount at once, known as a lump-sum investment, or you can opt for a Systematic Investment Plan (SIP). A SIP allows you to invest a fixed amount every month, which helps in building a disciplined saving habit and avoids the pressure of arranging a large sum at the end of the year. For beginners, a SIP is often recommended as it helps average out the purchase cost over time through a principle called 'rupee cost averaging'. If you invest via SIP, each monthly instalment has its own three-year lock-in period from its date of investment.
Understanding the Tax on Your Returns
While the investment itself provides a tax deduction, the returns you earn are also taxed, but in a favourable manner. Since ELSS has a three-year lock-in, any gains you make are classified as Long-Term Capital Gains (LTCG). Under current tax laws, LTCG from equity on gains up to ₹1 lakh in a financial year are tax-free. Any gain over this ₹1 lakh limit is taxed at a rate of 10%, without the benefit of indexation. This tax treatment makes ELSS a relatively tax-efficient product even at the time of redemption.
Getting Started with Your First ELSS Investment
Starting your ELSS journey is straightforward. The first step is to complete your Know Your Customer (KYC) compliance, which is a mandatory requirement for all mutual fund investments. This can often be done online through the website of a mutual fund house or a digital investment platform. Once your KYC is complete, you can choose an ELSS fund. While past performance is not a guarantee of future returns, you can look at a fund's long-term track record, the fund manager's experience, and its expense ratio before making a decision. You can invest directly through the mutual fund's website or use an online investment platform or a financial advisor.
