Equity Linked Saving Schemes (ELSS) : A Complete Guide

What are ELSS Funds?

ELSS funds are defined as equity funds that invest the majority of assets in equity or equity-related securities because they offer an exemption from tax of up to ₹1,50,000 from the yearly taxable earnings under Section 80C of the Income Tax Act. ELSS funds are also known as Tax-Saving Plans. An ELSS fund, as the name implies, is an equity-oriented programme with a three-year obligatory lock-in period. A lot of taxpayers have turned to ELSS schemes in recent years to take advantage of tax breaks.

ELSS funds are equity mutual funds that have a diverse portfolio. These funds generally invest in the stocks of publicly traded companies. The equities come from a wide range of market capitalizations (big, mid, and small corporations) and industries. These funds aim to maximise long-term wealth growth. To obtain the best risk-adjusted portfolio returns, the fund’s management selects stocks after doing rigorous market research. ELSS fund investments are deductible from taxes under Section 80C of the Income Tax Act of 1961. While there is no maximum investment amount, the IT Act permits a tax deduction of up to ₹1.5 lakh. Putting this sum in an ELSS could result in annual tax benefits of up to ₹46,800.

Geeky Takeaways:

• Section 80C provides tax benefits for ELSS.
• It has a three-year obligatory lock-in period.
• ELSS funds are mostly invested in stocks.
• Investors can modify their investment amounts as long as they stay under the total limit.
• Diversification of portfolios and management are handled by professional fund managers.

Features of ELSS Mutual Funds

ELSS mutual funds have the following features,

1. Lock-in Period: It has a minimum lock-in period of three years.

2. Equity Exposure: It puts at least 80% of its funds in stocks.

3. Tax Benefits: ELSS investments are tax deductible up to ₹1.5 lakh under section 80C.

4. Market-Linked Returns: It provides market-linked profits, and the performance is determined by the performance of the portfolio’s underlying shares.

5. Diversified Portfolio: The funds of ELSS generally invest in a diversified range of securities from multiple industries, reducing concentration concerns.

How Does ELSS Funds Work?

ELSS funds are equity funds with a diverse portfolio. These types of funds mainly invest in publicly traded firms’ stocks. The stocks are drawn from a variety of market capitalizations (big, mid, and small companies) and industries. These funds seek to optimise long-term wealth appreciation. The fund management selects stocks after doing extensive market research in order to achieve the best risk-adjusted portfolio returns. Investments in an ELSS fund are tax deductible under Section 80C of the Income Tax Act of 1961. Although there is no maximum limit on the quantity that can be put into it, the IT Act allows for a tax deduction of up to ₹1.5 lakh. Making investments of this sum in an ELSS can result in tax savings of up to ₹46,800 per year.

How Should You Invest in an ELSS Fund?

Equity Linked Saving Schemes (ELSS) can help you save taxes and profit from equity market growth. ELSS mutual funds invest mostly in equities and give tax benefits under Section 80C of the Indian Income Tax Act. Consider these steps while enrolling in an ELSS fund,

1. Understand the Fund: The ELSS funds have a three-year lock-in period during which you cannot redeem your units. Compared to PPFs and NSCs, this lock-in period is shorter.

2. Determine Investment Amount: Choose your desired ELSS investment amount.

3. Risk Profile Assessment: ELSS funds invest in shares, which are riskier than debt instruments. Evaluate your risk threshold and range of investments before investing. Long-term equity investments are advised. Pick an ELSS fund that matches your objectives for investing and risk tolerance. Past performance, fund manager history, fee ratio, and investment philosophy should be considered.

4. Review Fund Performance: Analyse the fund’s past performance throughout market cycles. Compare the fund’s returns against its benchmark index for consistency.

5. Assess the Fund Manager’s Experience and Track Record: A knowledgeable fund manager can boost performance. Also pay attention to expense ratio. Expense Ratio is the annual fee payable by the mutual fund for handling your money. Investors prefer lower expenditure ratios because they affect returns.

6. Lump sum vs SIP: Think about making investments via a Systematic Investment Plan (SIP) rather than with a flat sum. SIPs reduce market volatility by investing a fixed amount consistently.

7. Diversify: Investment principles emphasise diversification. Spread your ELSS investments among funds or different asset classes to lessen risk.

8. Monitor and Rebalance: Review the success of your ELSS investment regularly. If your financial objectives or market conditions change, rebalance your portfolio.

9. Tax Repercussions: ELSS investments may have tax repercussions upon redemption, despite tax benefits. Capital gains on equities investments are tax-free up to a specific maximum, but gains above that may be taxed.

10. Stay Informed: Stay aware of market developments, economic situations, and fund strategy/management changes.

Your financial objectives, tolerance for risk, and investment horizon should guide your investing decisions. Consult a financial counsellor before investing.

Why Should You Invest in ELSS Tax Saving Mutual Funds?

1. Saves Taxes and Builds Wealth:  To begin with, ELSS funds are mutual funds that invest in equity. They are basically multi-cap funds, which make investments in businesses of all sizes, large, mid, and small, and across all industries. And, as an equities mutual fund, it possesses the ability to generate long-term wealth through shares. However, another significant advantage of putting money into ELSS funds is the fact that you are eligible for a tax deduction of up to ₹1.5 lakh under Section 80C. This advantage is not available from any other mutual fund. So, if you are in the 30% tax bracket, you can save ₹46,800, including the 4% cess in income tax. Simply put, investing in ELSS, like any other equity mutual funds, allows you to build wealth over time. Furthermore, investment in ELSS provides tax advantages that no other mutual fund provides.

2. Shorter Lock in Period: When the lock-in period for ELSS is compared to other tax-advantaged investment choices, ELSS earns an extra point. The lock-in term for various popular tax-saving investment options is 15 years for PPF, 5 years for ULIP, 5 years for tax-saving FDs, and 5 years or 10 years for NSC. In comparison, the lock-in time for ELSS is only three years.

Investment Option	Lock-in period
ELSS	3 years
PPF	15 years
Tax-saving FD	5 years
NSC	5 years and 10 years
ULIP	5 years

3. Start Small: ELSS, like every other mutual funds, is simple to invest in via SIP. For as little as ₹500, you can begin a SIP for an ELSS mutual fund. And, like other mutual funds, you may increase the amount you invest through SIP top-up as your income grows. And, if you want to earn the entire tax benefit for investment in these funds, you can do so by putting in ₹12,500 every month instead of ₹1.5 lakh all at once. The majority of other tax-advantaged investment products do not offer a systematic means to invest money on a regular basis.

4. Taxation of Mutual Funds Allows You to Save More: The minimum lock-in period for ELSS funds is three years. After three years, long-term capital gains (LTCG) from ELSS mutual funds of up to ₹1 lakh per year are tax-free. However, LTCG in excess of ₹1 lakh is taxed at 10%. When comparing ELSS to PPF (which come under Exempt Exempt Exempt and so, the maturity amount is not taxed), you may believe that the advantage for investing in ELSS is less. However, it should be noted that PPFs have a very long lock-in period, and investments like this are not suitable for meeting short-term or mid-term goals. When compared to a 5-year FD, investment in ELSS is far more advantageous due to its taxation policy. The returns on FDs are taxed according to one’s tax bracket. Furthermore, if you are in the 30% tax level, your FD profits will be taxable at 30%. Meanwhile, LTCG beyond ₹1 lakh in ELSS or any other mutual fund is taxed at 10%. That is, your earnings are taxed at a rate of 10%.

Taxation Rules of ELSS Funds

Because ELSS money are locked up for three years, there is no possibility to profit in the short term. As a result, only long-term capital gains are possible. These profits are tax-free up to ₹1 lakh per year, after which they are subject to a 10% long-term capital gains tax.

As previously stated, Section 80C of the Income Tax Act provides tax benefits on the principal invested in an ELSS scheme. This is a cumulative deduction benefit, which means you can claim a tax deduction of up to ₹1.5 lakh under the aforementioned provision for investments made in all specified instruments, such as ELSS, NSC, PPF, and so on. Furthermore, these programmes are subject to a three-year lock-in term. As a result, when you redeem the units, you obtain long-term capital gains, or LTCG. These earnings are not taxable up to a limit of ₹1 lakh in a single fiscal year. Without indexation, any LTCG above this amount is taxed at 10% of the gains in excess of ₹1 lakh.

Factors to Consider Before Investing in ELSS

ELSS Funds, also known as Equity Linked Savings Schemes, are sometimes known as tax-saving funds since they are the only equity funds that provide tax benefits in addition to the benefits of investing in the stock market. ELSS funds have emerged as a popular tax-advantaged investing option in recent years. In this essay, we will discuss some crucial information concerning ELSS funds.

1. ELSS Fund Asset Composition: An ELSS fund’s fund management invests at least 80% of the fund’s assets in equity and equity-related products. The remainder, depending on the scheme, can be deposited in fixed-income or money market securities. Furthermore, fund managers can select which stocks to put their money in based on the fund’s aim and risk level. As an example, an ELSS fund with a high level of risk may invest more in small-cap stocks than a Medium-risk ELSS fund that invests more in large-cap firms.

2. The Lock-In Period: Most investments that provide tax benefits under Section 80C of the Income Tax Act of 1961 require a lock-in period. ELSS funds have the shortest lock-in duration of three years when compared to other investments in the sector. As a result, you cannot redeem ELSS fund units before three years have passed. This aids in the generation of compounded returns. Other Section 80C investments, such as PPF, have a 15-year lock-in period, while NSC has a five-year lock-in period. As a result, ELSS funds with minimal lock-in and the possibility for market-linked returns are worth considering for inclusion in your tax-saving investing portfolio.

3. SIP Investing in ELSS Funds: A Systematic Investment Plan, or SIP, is a method of investing small amounts in mutual funds on a regular basis. It enables you to profit from the Rupee Cost. Averaging to reduce the average cost of purchasing mutual fund units. While SIPs are typically seen as an excellent way to begin investing, they are especially useful when markets are in decline. A SIP allows you to invest a certain amount at regular intervals and buy units at the current NAV. So, if the markets are decreasing, you buy more units gradually, lowering the average cost of acquisition. This eliminates the risk of investing in a large sum at the height of the market. The lock-in period applies to every purchase in an ELSS fund. As a result, if you have chosen a SIP with a monthly frequency, the investment made each month has a three-year lock-in beginning that month.

4. Risk Level: Since ELSS funds invest largely in equities and equity-related securities, the risks are comparable to those associated with stock investing. This does not, however, imply that all ELSS funds are high-risk investments. To appeal to diverse sorts of investors, fund managers provide ELSS funds with varying risk profiles. When investing, keep in mind that significant risks are frequently coupled with big potential gains. Make sure that your investments are based on your financial goals and investing strategy.

Advantages of ELSS

1. Tax Savings: The amount of money invested in an ELSS fund is eligible for a tax deduction up to ₹150,000 for the current fiscal year under the provisions of section 80C of the Income Tax Act. This is the only method that enables investors to reduce taxes while generating substantial profits on stock fund investments.

2. Shortest Lock-in term Among Other Tax Saving Funds: ELSS has a 3-year lock-in term, compared to a minimum of 5-years among other tax-saving options. With respect to other tax-saving choices, such as fifteen years in a PPF or five years in a Fixed Deposit, this time is the shortest. As a result, ELSS offers larger returns with the shortest lock-in period.

3. Lower Capital Gains Tax: An ELSS fund invests for a minimum of three years. Profits from the selling of ELSS funds are so long-term in nature. Gains in excess of ₹100,000 are taxed at a rate of 10% under current law. Short-term capital gains, on the other hand, are taxed at a rate of 15%. As a result, ELSS funds automatically result in decreased tax expenses.

4. Advantages of Compounding: It is normally recommended to make investments in equity funds over an extended time horizon of 5-10 years. Because of the lock-in period, ELSS funds automatically result in a disciplined long-term investment. This technique allows investors to profit from the potential of compounding over time.

5. Optional Redemption: If the investors are pleased with the performance of the respective ELSS fund, they may decide to continue. After three years, redemption is not required. It is merely a minimum investment period; there is no maximum investment period.

6. Increased Profits: Because ELSS funds invest in equity schemes, their returns are larger (15-20%) than those of other tax-saving options (7-10%). Over a three-year period, the advantage of compounding combined with equity returns gives investors with larger returns. ELSS typically generates returns in the range of 15-20%. This is the highest among other tax-saving options, such as PPF and FD over 5 years.

7. SIP is an Option: Investors may use the SIP option when investing in ELSS. It enables the investor to make investments of a set amount on a regular/periodic basis. This enables employees to invest a particular amount from their savings on a regular basis, typically once a month.

8. Trustworthy and Open: Investment in a mutual fund is relatively straightforward. SEBI regulates all mutual fund businesses, and they must make all required disclosures.

Disadvantages of ELSS

While ELSS funds have numerous advantages, you should also consider the following factors while investing in them,

1. Higher Risk: ELSS funds are also more risky because they are directly connected to the equity market. Equity-related investments are more volatile in the market. As a result, ELSS mutual funds are high risk.

2. Limited Liquidity: The liquidity of ELSS mutual funds is limited. Because the lock-in term is three years, investors should be aware that their funds will be unavailable during that time.

3. Risk-Averse Investors Should Avoid This Investment: If risk is an issue, ELSS funds might not be the ideal option. A risk-averse investor would prefer a lesser return but safer choice, such as life insurance or PPF.

4. Limited Benefits: While there are tax breaks available, they are restricted in scope. Even if the total amount invested is greater, you can only claim a tax benefit of ₹1.5 lakhs in a fiscal year.

5. Management Expenses: ELSS funds are frequently handled by a fund manager, which can be pricey. You must pay a price for their professional assistance.

Comparison of ELSS with Other Tax Saving Instruments

Other tax-saving instruments are available on the market that can help you make higher profits while saving taxes. The returns on these assets are limited to fixed returns that may not be able to outperform inflation. This is not the case with ELSS, which invests in equities with a high potential for returns that can outperform inflation. It is also the only tax-saving scheme with a three-year lock-in term. Here’s a short summary of the ELSS and other tax-advantaged investments:

Investments	ELSS	Public Provident Fund (PPF)	National Savings Certificate (NSC)	5 Year Tax-Saving Fixed Deposits	National Pension Scheme (NPS)
Type of Investment	Mutual Fund (Equity)	Government Scheme	Government Scheme	Bank Fixed Deposit	Pension Scheme
Lock-in Period	3 years	15 years	5 years	5 years	Till Retirement
Risk Level	High	Low	Low	Low	Moderate to High
Expected Returns	Market-linked	7.1% (Keeps changing)	7.7% (Keeps changing)	Around 6% to 7%	Market-linked
Tax Deduction Limit (Section 80C)	Up to ₹1.5 lakh	Up to ₹1.5 lakh	Up to ₹1.5 lakh	Up to ₹1.5 lakh	Up to ₹1.5 lakh

Conclusion

ELSS funds are a wonderful alternative for long-term investors who want to gain exposure to the stock market while saving taxes. Various ELSS funds are available to the users. Investigate your options and select a fund that fits your financial goals while also lowering your tax liability.Before making investments in ELSS or any other financial instrument, investors should undertake thorough research, examine their financial goals, and consider their risk tolerance. Furthermore, remaining informed about market circumstances and monitoring your investment portfolio on a regular basis are critical for making informed selections.

Frequently Asked Questions (FAQs)

1. What exactly are ELSS funds?

ELSS funds, or Equity Linked Saving Scheme funds, are tax-advantaged mutual funds that invest primarily in equity programmes. ELSS investments are tax-exempt under Section 80C of the Income Tax Act.

2. What is the duration of the lock-in term in ELSS Funds?

The lock-in period for ELSS Mutual Funds is three years.

3. Why should someone invest in ELSS?

ELSS provides significant advantages over other traditional tax-saving instruments such as FDs, NPSs, and so on. It offers the shortest lock-in period and higher returns than the other tax-saving programmes.

4. Who should buy ELSS funds?

These funds are appropriate for salaried individuals as well as first-time investors.

5. What is the level of risk for ELSS funds?

ELSS funds must invest at least 80% of their assets in equities.