Q. I am a 25-year-old private bank employee working in Delhi. I was recently promoted and got a salary hike along with the same. I am now thinking of investing some amount of my salary in mutual funds for investment as well as for tax saving purposes. I was planning to invest in ELSS mutual funds but am unaware of the important features like tenure, lock-in period, taxation etc. Can you please throw some light on some basic features of ELSS mutual funds?
Mr. Ajay Sharma, New Delhi
ELSS funds are equity funds that allow you to save tax while you invest for your goals. This scheme is called the Equity Linked Saving Scheme (ELSS), and under this scheme, investments made in ELSS mutual funds are exempt from income tax under Section 80C of the Income Tax Act, 1961 up to a limit of Rs. 1.5 lakh per year.
What is an ELSS mutual fund?
An ELSS fund is a type of equity mutual fund that enables investments along with tax exemption under Section 80C of the Income Tax Act. One of the best ways to profit from the stock market and save tax simultaneously is by investing in ELSS mutual funds. By investing in ELSS funds, you can receive an annual tax exemption of up to ₹1,50,000 from your taxable income. ELSS mutual funds have a three-year lock-in period, which is mandatory and cannot be waived in any condition.
Here are some crucial characteristics of ELSS mutual funds that you might find interesting:
- An ELSS fund, as the name implies, invests your money in equity and equity-related instruments. It implies that the asset management firm will put at least 80% of your funds into equities. Different investment strategies can be used by each organization to lower risks.
- Most ELSS mutual funds will also pick a selection of equities depending on their market capitalisation and potential for future growth.
- Investment through a lump sum investment or through a systematic investment plan (SIP) can be made in the ELSS mutual funds. You will need to make periodic investments in the case of SIP. SIP is a more convenient option if you do not want to make a lump-sum investment.
- There are no guaranteed returns offered by ELSS funds. These funds typically have a high level of risk because of their focus on the stock market and since they invest 80% of their corpus into equities.
- The maximum investments you can make in an ELSS are not capped. To start your investment, you can put in as little as Rs. 500.
READ MORE: Income tax saving and greater returns; What's not to love in ELSS funds? Find out more
Important attributes of ELSS mutual funds
Shortest Lock-In Period
Long lock-in periods are a feature of popular tax-saving options like the Public Provident Fund (PPF) and tax-saving Fixed Deposits (FDs). For instance, the lock-in period for PPF is 15 years, whereas the lock-in period for tax-saving FDs is 5 years. ELSS funds, in contrast, have a lock-in period that is only three years long.
Under Section 80C, you can reduce your taxable income on investments by up to Rs. 1.5 lakh each year if you choose to invest in ELSS Mutual Funds. If you choose to sell your ELSS Mutual Funds units, you will be liable to pay long-term capital gains tax (LTCG Tax) on the gains you make. LTCG tax is exempt for capital gains (LTCG) up to Rs. 1 lakh. Beyond that, you will be liable to pay tax at the rate of 10%.
Compared to other tax-saving options like PPF or NPS, top ELSS funds may offer better returns. The risk that fund houses take when they invest in stocks is what makes these high returns possible. However, the risk associated with these funds is higher than with other funds.
ELSS mutual funds are managed by professional fund managers. Compared to other tax-saving schemes, the expert advice provided by these managers helps investors to achieve higher returns. Therefore, even an investor with limited or no market knowledge might get the best returns by investing in ELSS mutual funds.
What factors ought to be taken into account before investing in ELSS funds?
Examining an ELSS fund's long-term performance is crucial before investing. In addition, here are some other things to think about before opening an account.
Liquidity - Because ELSS mutual funds have a three-year lock-in period, it's crucial to think about your expenses before investing in one of these funds. You cannot cease investing in a fund in the middle of it.
Tax Planning - Many consumers invest in ELSS funds because of the potential tax-saving opportunity. If tax planning is your sole issue, you may want to consider other alternative options. For instance, your investments in other schemes like National Pension Scheme (NPS) and Public Provident Fund (PPF) are also eligible for a tax deduction under Section 80C of the Income Tax Act.
Investment Horizon - You might want to reevaluate your selections if you intend to sell your investments after the lock-in term. As an ELSS invests your money in equities, it may require 5-7 years to stabilize and give you good returns. ELSS funds are sometimes advised if you have a longer time horizon because the stock market is unpredictable and subject to cyclical ups and downs.
ELSS funds could be considered by all investors seeking a tax-advantaged investment option that generates income. They are highly recommended for persons who have a low-risk tolerance and appetite, such as those with modest incomes. There are no age restrictions on investing in ELSS funds.
Consequently, recently employed professionals can also invest their hard-earned money in these schemes. ELSS funds are an option for investors who want to diversify their assets and are looking for a new alternative to expanding their portfolio.
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Note: This story is for informational purposes. Please speak to a financial advisor for detailed solutions to your questions.