Income Tax Saviour – ELSS Funds?

Equity-Linked Savings Scheme (ELSS) funds come with all the benefits of mutual funds such as diversification, professional management by fund managers, low minimum investment amount, and more. However, they have one unique benefit that other mutual funds do not have. ELSS funds come with tax benefits and are a popular tax-saving instrument that many equity investors consider a tax saviour. Here’s what you need to know.

Section 80C benefit

There are specific investments that allow for a tax deduction of up to Rs 1.5 lakh every year under section 80C of the Income Tax Act, 1961. What this means is that you can deduct the amount you have invested in these investments from your income before your tax liability is calculated.

Popular section 80C tax-saving instruments include ELSS funds, the National Pension System (NPS), Public Provident Fund (PPF), five-year fixed deposits, and National Savings Certificate (NSC). So, for instance, if you invest Rs 1 lakh in ELSS funds in a given financial year and Rs 45,000 in NPS, you can claim a deduction for both these investments under section 80C.

Why are ELSS tax-saving funds beneficial?

Here are the three reasons that most investors look at ELSS funds as a tax saviour:

  • Highest potential returns

Being equity-oriented investments, ELSS returns are market-linked which means that they have the highest return-earning potential compared to all other tax-saving investments. While a tax-saver fixed deposit usually comes with an interest rate of 5 to 6% and PPF’s current rate is 7.10%, ELSS funds have the potential to earn returns at 15 to 18%.

  • Shortest lock-in period

Every section 80C investment comes with a mandatory lock-in period before which you cannot sell your investment. Some of these instruments such as PPF come with a 15-year lock-in period while others like NPS have a lock-in period till retirement. ELSS tax-saving funds, on the other hand, have a lock-in period of only three years. This is the lowest lock-in period out of all the tax-saving instruments and hence ELSS funds win when it comes to liquidity in this context.

  • LTCGs exemption

Another tax aspect to consider when investing is whether the returns of the investment are taxed and to what extent. The returns on ELSS funds are not entirely tax-free. When you make a profit on the sale of ELSS funds, it’s considered as Long-term Capital Gains (LTCGs) and is taxed at 10%. However, the ELSS funds LTCGs are exempt from LTCGs tax up to Rs 1 lakh.

Mode of investing in ELSS tax-saving funds

When you want to invest in ELSS funds, you have the option to make a lumpsum investment or opt for the Systematic Investment Plan (SIP) option. Whether you invest Rs 1.5 lakh in one go in ELSS funds or through a SIP over the financial year, you can still claim the section 80C tax deduction.

This is beneficial because the SIP mode allows you to invest lower amounts across the year and still avail of the tax benefits. Hence, you don’t need to wait to have a huge amount of money set aside before you invest in ELSS. You can start even if you have as little as Rs 500 to spare each month.

The bottom line

ELSS tax-saving mutual funds allow you to build wealth and reduce your tax liability at the same time. They are one of the best tax-saving options out there owing to their short lock-in period and potential to earn high market-linked returns. It’s important to note, however, that the section 80C benefit is not available for any investment if you are following the new tax regime with lower income tax slab rates. Hence, make sure to consult your financial advisor about the same before making any investment decisions.

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