What is a ELSS fund? ELSS funds meaning, tax benefit, etc.

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If an investor can get a to save in taxes, earn higher returns & compound money over a long period of time, then what more an investor would need. ELSS fund full form is equity-linked saving scheme & is also called tax saving mutual funds.

ELSS is equity or equity-oriented fund that is exempted for investors putting in money up to 1.5 lacs under sec 80C of Income-tax Act, 1961.

1. ELSS funds meaning

Under sec 80C of  Income Tax Act, 1961 an individual or HUF can invest in equity or equity-oriented mutual fund and claim an exemption for the same up to 1.5 lacs p.a. 

The amount withdrawn after the lock-in period is tax same as equity long-term capital gains. Generally, the investment portfolio of this type of fund invests 80%  in equity and the rest in debt or money market instrument.

The ELSS fund has a lock-in period of 3 years which is the shortest as compared to other tax-saving schemes, for example, PPF has a locking period of 15 years.

2. Who should invest in an ELSS fund?

a. Salaried Individuals

If you are a salaried employee then a certain amount would be going every month to an employee provident fund which is mostly matched by the employer,  this is a fixed income product.

An individual who wants to take advantage of tax policies and invest in the growth of the economy, can buy units of an ELSS fund and can save in tax up to 1.5 lacs per annum.

There are more advantages to this which include compounding and SIP (Systematic investment plan) which will be explained later in the article.

b. Not risk-averse

This fund invests in equity instruments so the NAV of the scheme will fluctuate in the short run due to stock price fluctuation; but if an investor is willing to keep his money invested for a period of more than 5 years, he will be benefited from the same.

c. Long term investment horizon

As the lock-in period in this fund is of 3 years and also they invest in equity instruments the investor should buy this fund only if he has a long-term investment horizon. If you need the money in a short-term period for example six months or in one year he is better off investing in other schemes. 

Also after the lock-in period is over it is less likely that an investor will achieve an extraordinary return because in the short run the share price fluctuations can be wild and he may not be able to achieve his financial goals. 

3. Advantages and disadvantages of ELSS

i. Advantages of ELSS fund

a. ELSS tax benefits

The major advantage of investing in ELSS is the tax benefit. If an investor invests in an ELSS fund, he is not charged up to 1.5 lacs of his income under section 80c of the Income Tax Act.

For Example: If a person’s tax liability is ₹600000 and if he invests ₹150000 in an ELSS fund then his total tax liability will reduce to ₹450000.

b. Shortest lock-in period

As compared to other tax-saving schemes ELSS has the shortest lock-in period that is of three years. The lock-in  period of other tax saving schemes are as follows

Investment option Lock-in period
ELSS 3 years
NSC 5 years
PPF 15 years
NPS Till retirement

c. Higher returns 

ELSS fund gives a higher return as compared to other tax-saving schemes because it invests in the equity market whereas other schemes are fixed income products.

But with high returns investors also have to bear the higher risk as in the short-run stock market can be volatile and also an investor should know how to evaluate a mutual fund before investing.

d. Compounding 

If an investor chooses an ELSS growth fund then the returns on the funds will be reinvested and the investor will get a compounding effect that will multiply his money greater than any other scheme at a higher rate of returns.

Also, it is recommended to investors to choose a growth fund over a dividend fund while investing in the ELSS fund if in case he wants to reinvest his profit. The reason for this is three years lock-in period in case of a dividend fund starts from the time when the dividend will be received,  will learn more on this later in the article.

Also read: What is compounding?

ii. Disadvantage of ELSS fund

a. Return is taxed

The gain from this fund is taxed as regular income from equity long-term capital gain which is explained in detail in the last point.

b. Not for conservative investors

The ELSS fund invests in equity markets so the risk associated with it is high as compared to other tax-saving investments because they are fixed income products.

c. No Guaranteed return

The equity markets can fluctuate wildly over a short period of time so, there is no guaranteed return in the ELSS fund. If an investor wishes to have a guaranteed return & save taxes he can invest in PPF & NSC.

elss meaning

4. Lock-in period for SIP

What is the lock-in period? It is the time before which an investor cannot withdraw money from the fund. Otherwise, if he withdraws before the lock-in period is over he will be liable for a penalty.

The lock-in period as already discussed is 3 years for an ELSS fund. But usually, people get confused about this period in the case of SIP. The 3 years period starts from the time of every installment invested in the fund. 

For Example:- If a SIP installment is invested on 31 April 2020 then the lock-in period will complete on 31 April 2023 & if the amount is invested on 31 May 2020 then the lock-in period will be up to 31 May 2023.

5. ELSS sip & lumpsum.

Individuals usually start to plan their taxes at the end of the year when they are due to furnish their returns and pay taxes. They usually tend to buy in a lump sum into an ELSS fund which may be risky as compared to SIP. The reason for the same is that the market can be overvalued at a particular time so investing via a SIP in an ELSS fund will reduce this risk by dollar-cost averaging over a 12 month period.

6. Taxation on ELSS fund

The gain on ELSS funds is a tax as equity long-term capital gain so the amount up to ₹100000 is tax-free and the rest is tax at the rate of 10%.

For Example:- If the total gain is 300000, then 100000 is tax-free & the rest of the amount is tax at the rate of 10% i.e.20000 (200000*10%).

Also read : Capital gain taxes impact (In India)

To learn more about ELSS funds go to cleartax.in

Disclaimer

I am not a SEBI registered investment advisor. This article is for information purposes any scheme or company name mentioned here is just for example & not a recommendation. 

Mutual Fund investments are subject to market risks, read all scheme related documents carefully. The NAVs of the schemes may go up or down depending upon the factors and forces affecting the securities market including the fluctuations in the interest rates. The past performance of the mutual funds is not necessarily indicative of the future performance of the schemes. 

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