Understanding ELSS Mutual Funds: A Tax-Saving Investment Avenue

Equity-linked savings scheme (ELSS) are mutual funds that help investors generate wealth for the long-term while also providing them with tax benefits. The corpus is invested with heavy exposure into equities. Thus, for those looking at benefiting from tax exemptions under Section 80C of the Income-tax Act, 1961, ELSS provide the best of both worlds – wealth creation over the long term, and benefits of taxation.

What Are ELSS Mutual Funds? 

ELSS invest mainly in equities or equity-related instruments, which make them an equity-oriented mutual fund scheme. Investors can also claim deductions of up to Rs 1.5 lakh under the overall limit of under Section 80C of the Income-tax Act, 1961, as deduction from their annual taxable income.

However, any returns made from these funds attract 12.50 per cent tax for long-term capital gains (LTCG) if the capital gains exceed Rs 1.25 lakh in a year.

One of the prime distinguishing features of ELSS is the mandatory lock-in period of three years, which means that investors cannot withdraw this amount before the mandatory lock-in period is over.

Even then, the major attraction for most investors is the potential of equity-oriented growth along with tax benefits under Section 80C.

Key Highlights Of ELSS 

Equity Orientation: A minimum of 80 per cent of the total corpus is invested in equity or equity-related instruments. 

Diversified Portfolio: ELSS funds invest in diversified sectors and companies of various market capitalisations, such as large-cap, mid-cap, and small-cap, thereby reducing the risk through diversification. 

Tax Benefits: Investments in ELSS are exempt up to Rs 1.50 lakh under Section 80C of the Income-tax Act, 1961.

Flexible Tenure: Although ELSS comes with a mandatory lock-in of three years, investors may continue to remain invested beyond the lock-in period to benefit from the power of compounding.

How Do ELSS Funds Work?

ELSS funds involve creating a diversified portfolio of stock from multiple industry bases and market sizes. The fund managers research to determine the proper stocks to balance the risk and return, keeping in mind the long-term creation of wealth. 

Being an equity-based fund, ELSS is riskier than debt options, such as Public Provident Fund (PPF). But at the same time, the chances of getting higher returns are more, especially if you hold on to your investments for a longer duration. After the three-year lock-in period is over, you can either continue investing in the same scheme, or liquidate your investment.

Why Invest In ELSS Funds? 

Low Entry Point: Many ELSS funds allow investors to start with as little as Rs. 500, which is accessible for most people. 

SIP: Investors can invest in ELSS through systematic investment plans (SIPs), which allows for regular and disciplined investing and reduces market volatility by way of rupee cost averaging. 

Long-Term Growth: ELSS funds have a three-year lock-in period, but equity exposure can translate into potential capital appreciation over time. Investors may even hold on to their investment beyond the lock-in period to cash in on more appreciation. 

Tax Rules Of ELSS 

ELSS funds attract LTCG tax. Gains above Rs 1.25 lakh in a financial year are taxable at12.5 per cent. Note that this is in relation to the earnings earned after the lock-in period. As such, one cannot earn short-term capital gains on ELSS investment. 

Another great advantage of ELSS is that its investment qualifies for tax deduction under Section 80C.

ELSS is a good investment option for investors wanting to invest in equity-oriented mutual funds while also taking the benefit of taxation under Section 80C at the time of investment.

The combination of equity exposure, tax benefit, and capital appreciation makes these funds very attractive for investors willing to invest over the long horizon. However, as with any other investment, one should invest in them keeping in mind one’s investment goal and risk appetite.