Tax planning is an essential aspect of financial well-being and health – an aspect that faces procrastination and contemplation as its biggest challenges. People tend to invest in government schemes such as Public Provident Funds or National Security Certificate (NSC) schemes that go the traditional route. These options provide single-digit returns, and so, despite being safe, do not offer significant growth opportunities. Investing your hard-earned income at the eleventh hour to save it being taxed, can be cause for losses too. Educating yourself in more richly rewarding avenues to invest in is certainly a prudent decision to make. Investing in Mutual Funds is one option you’re likely to come across, where you can invest in some of the best tax saving mutual fund offering tax benefits as well as long term capital appreciation. Such mutual funds are called ELSS, or Equity Linked Saving Schemes.
ELSS Mutual Funds: An outline
ELSS or Equity Linked Saving Schemes are best tax saving mutual funds based on the equity markets. They are the only category of mutual funds that are eligible for tax deductions. They come with an essential lock-in period of 3 years – the shortest among all the investment schemes and deposits mentioned under 80C of the Income Tax Act. However, the investors are free to extend the period to 5 or more years.
An investor may select the growth option under their ELSS scheme and have their dividends invested into growing the NAV of the fund, leading to higher gains at the time of redemption. They can also go in for the Dividend option too where the dividends received are completely tax-free. The third option – Dividend Reinvestment – allows for the reinvestment of dividends received to add to the NAV of the investment under the mutual fund.
Ins and Outs of ELSS mutual funds
- Higher Returns: Besides the shortest lock-in period of three years, ELSS funds offer generally higher returns to investors when compared to PPF (15 years as a lock-in period) and NSC schemes (6 years). Due to a fixed lock-in period, the tax saving mutual fund is better positioned to overcome market fluctuations to yield healthy returns. The fund makes investments in equity and equity-related instruments only. This assures higher returns when compared to term deposits and PPF.
- Tax Deductions: Earnings from ELSS attract long term capital gains tax of 10%. ELSS schemes carry the benefits of traditional mutual fund schemes – you may not be adept with the selection of the portfolio of investment or a good analyzer of market fluctuations, but professional experts are available to do that for you. Moreover, there is no limit to how much you can invest in these schemes.
- Flexibility: ELSS investments can be made in lump sum or in installments starting as low as Rs. 500. There is no upper limit to the investment amount. The tax benefit, however, is limited to Rs 1.5 lakhs per year under Section 80C of the Income Tax Act. ELSS funds are available in both dividend and growth options.
- Tax-free Dividends: Besides regular tax savings, dividends from ELSS investments are also tax-free. ELSS schemes offer regular dividends, with no maximum limit on the dividend received and eligible for exemption.
Though ELSS schemes offer higher returns, they also carry some risks. The risk profile of any ELSS fund is in line with that of any equity-oriented scheme. The returns can, therefore, be entirely the consequence of market performance. For those uncomfortable with lock-in periods, the lack of premature withdrawal within 3 years may be an issue. These schemes are not applicable for the residents of Canada and the United States. Thus, any Indian residing in these two countries is kept outside the ambit of the tax deduction benefits under this scheme. A lot of documentation is involved while making an investment.
Pointers to be kept in mind before investing in ELSS schemes:
- Avoid investing in ELSS solely because of their superior returns. You may want to remember that these higher returns come with elevated risk. Your risk appetite and tolerance for market volatility should be a factor in your decisions.
- Schemes with higher exposure to mid-cap and small cap stocks are likely to be more volatile and bring even more risk. ELSS funds primarily invest in stocks, and their performance is an outcome of market performance.
- As mentioned above, ELSS tax saving funds feature a compulsory lock-in period of 3 years as per the tax saving investment options available under 80C of the Income Tax Act, 1961. To yield greater returns, you may want to consider investing for a period of five to seven years and not restrict yourself to the mandatory period only.
- There is no need for these options to be considered separate from your regular financial investments. ELSS schemes give you the benefit of tax savings plus let you survive in the long run.
Nearly all major fund houses cater to the tax saving needs of their investors and have consequently put forth their own best tax saving mutual fund schemes. Some popular schemes include the likes of Aditya Birla Sun Life Tax Plan, Aditya Birla Sun Life Tax Relief 96, Axis Long Term Equity Fund, HDFC Long Term Advantage Fund among others. Each of them seeks to benefit the investors through capital gains on one hand and tax savings on the other.