Financial Awareness Level
A simple guide to understanding Equity-Linked Savings Scheme (ELSS)
Equity-Linked Savings Schemes (ELSS) are a category of tax-saving, equity mutual fund schemes. Investing in the ELSS scheme category aims to offer two benefits: direct savings on the income tax payable and the opportunity to let the invested money grow through exposure to equities.
ELSS in action
The rightmost three columns in Table 1 show three annual income brackets: people earning ₹ 5 lakh (5% tax bracket), ₹ 10 lakh (20% tax bracket), and ₹ 20 lakh (30% tax bracket). Investing in an ELSS fund will allow people in each of these brackets to claim an income tax deduction of up to ₹ 1.5 lakh under section 80C of the Income Tax Act, 1961.
So, what is the benefit? For example - The total taxable income of a person earning ₹ 20 lakh will drop to ₹ 18.5 lakh (₹ 20 lakh minus ₹ 1.5 lakh deduction gives ₹ 18.5 lakh, see the rightmost column in Table 1). If the ₹ 20 lakh income person invests money in an ELSS fund, their net tax savings will be ₹ 46,800. This is apart from the potential gains of investing (subject to market risk) in the ELSS fund. Note that there is an investment limit of ₹ 1.5 lakh per annum for deductions under 80C.
Table 1: Potential tax savings, Illustrative data (Old Tax Regime)
| Particular | Tax Bracket | ||
|---|---|---|---|
| 5% | 20% | 30% | |
| Gross Total Income (A) | ₹5,00,000 | ₹10,00,000 | ₹20,00,000 |
| Tax paid: No 80C investment (with cess) (B) | ₹13,000 | ₹1,17,000 | ₹4,29,000 |
| Investment in ELSS under sec 80C (C) | ₹1,50,000 | ₹1,50,000 | ₹1,50,000 |
| Total Income after 80C deduction (A-C) | ₹3,50,000 | ₹8,50,000 | ₹18,50,000 |
| Tax paid after claiming deduction under sec 80C (D) | ₹5,200 | ₹85,880 | ₹3,82,200 |
| Tax Savings (B-D) | ₹7,800 | ₹31,200 | ₹46,800 |
ELSS vs Other 80C options
Besides ELSS, various investment options are available under section 80C of the Income Tax Act, 1961, for claiming deductions (tax savings). These include Public Provident Fund (PPF), National Savings Certificate (NSC), insurance premiums, and Fixed Deposits with 5-year maturities (see Table 2).
Investing in ELSS funds has two advantages over these options:
- First, ELSS has one of the shortest lock-in period of 3 years. In contrast, PPF has a lock-in of 15 years; insurance policies (ULIPs) typically have a 10-15 year maturity period, a longer surrender period, NSCs have a lock-in of 6 years, etc.
- Second, investors have the potential to earn higher returns as compared to other alternatives (subject to market risk). For e.g., the average 10-year returns (as of 30th Dec 2022) for all ELSS funds is 12.86%.The average 3-year and 5-year return for ELSS funds are 16.48% and 7.86%, respectively*. Depending on needs, investors choose to remain invested in ELSS funds beyond the 3-year period as well.
*Source: MFI Explorer, as of 30th November 2022
Table 2: ELSS vs Other 80C options
| ELSS | ULIP | PPF | NSC | SSY | Tax Saving FD | |
|---|---|---|---|---|---|---|
| Lock-in period | 3 years | 5 years | 15 years | 5 years | 21 years | 5 years |
| Max Investment for Sec 80C deduction | Rs 1,50,000 | |||||
| Return % (p.a) | Market linked | Market linked | 7.1% | 7.0% | 7.6% | 6.5% |
As of 15- Feb-2023, ^ FD interest for SBI considered
ULIP: Unit Linked Insurance Plan, NSC: National Savings Certificate, PPF: Public Provident Fund,
FD: Fixed Deposit
Source: SBI, NSI India
Tax Efficiency
ELSS fund returns are subject to Long Term Capital Gains (LTCG) Tax when redeemed. The Long Term Capital Gains Tax is 10% (plus cess and surcharge). Gains up to ₹ 1,00,000 under LTCG are exempt from tax. In contrast, the interest on bank fixed deposits is taxed at the investor’s marginal tax rate.
Flexibility
Investors can make their ELSS investments either as a lump sum or through systematic investment plans (SIPs). A SIP can be started with a minimum amount of ₹ 500.
Note: Investors should be aware that the fiscal rules/tax laws may change, and there can be no guarantee that the current tax position may continue indefinitely. In view of the individual nature of tax consequences, each investor is advised to consult their own professional tax advisor.
Source: Russian Journal Of Economics, Volume 1 Issue 3, September 2015
The information contained in this document is for general purposes only and not an investment advice. Readers should seek professional advice before taking any investment related decisions.
MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS. READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
FAQ Section
What is an ELSS fund?
Equity-linked savings schemes (ELSS) are a particular category of equity mutual fund schemes. ELSS mutual funds invest their corpus in equity or equity-related products. ELSS funds are eligible for an income tax deduction of up to ₹ 1.5 lakh under Section 80C of the Income Tax Act, 1961
What are the advantages of investing in an ELSS fund?
Investing in ELSS funds has the following advantages:
- An income tax deduction (that is, the tax payable becomes lesser) of up to ₹ 1.5 lakh
- Exposure to the equity asset class and potential to benefit from India’s economic growth through investing in equities
- Investing in equities allows investors the opportunity to beat inflation and also contribute to their long-term wealth creation plan
- Investors can use Systematic Investment Plans (SIPs). Over time, SIPs reduce the effect of market timing
Is investing in an ELSS fund mandatory?
Investing in ELSS funds is not mandatory.
What are the factors to consider before investing in an ELSS fund?
- If you are getting 80C benefits from other investments, there will be no additional tax benefit from ELSS funds
- ELSS funds have a lock-in period of 3 years
- Equities investing benefits from long time horizons; historically, the risk of negative returns for index investors over a 20-year period approaches zero (*)
Should I invest the money through a lump sum amount or should I use a SIP?
It depends on the availability of funds and the comfort level of using SIPs. Investing through Systematic Invest Plans reduces the risk of market timing. Buying smaller amounts of the ELSS fund and spreading these amounts over a longer time reduces the risk of buying at too high a price.
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Disclaimer
An Investor Education And Awareness Initiative Visit https://www.hdfcfund.com/information/key-know-how to know more about the process to complete a one-time Know Your Customer (KYC) requirement to invest in Mutual Funds. Investors should only deal with registered Mutual Funds, details of which can be verified on the SEBI website (www.sebi.gov.in/intermediaries.html). For any queries, complaints & grievance redressal, investors may reach out to the AMCs and / or Investor Relations Officers. Additionally, investors may also lodge complaints directly with the AMCs. if they are not satisfied with the resolutions given by AMCs, they may raise complaint through the SCORES portal on https://scores.gov.in. SCORES portal facilitates investors to lodge complaint online with SEBI and subsequently view its status. In case the investor is not satisfied with the resolution of the complaints raised directly with the AMCs or through the SCORES portal, they may file any complaint on the Smart ODR on https://smartodr.in/login.
