Equity Linked Saving Scheme (ELSS): A Comprehensive Guide

Equity Linked Saving Scheme (ELSS): A Comprehensive Guide

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Rashmi
Rashmi Karan
Manager - Content
Updated on Nov 24, 2023 15:31 IST

Equity Linked Saving Scheme (ELSS) is a popular and tax-efficient investment option in India that combines the benefits of wealth creation and tax savings. ELSS funds are a subset of mutual funds primarily invested in equity and equity-related instruments. ELSS is also known as tax-saving funds. Let us explore more about ELSS in detail.

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What are ELSS Funds?

An Equity Linked Saving Scheme (ELSS) is an open-ended equity mutual fund. It allows Indian investors to save taxes under Section 80C of the Income Tax Act, 1961, by investing primarily in equities and equity-related products. ELSS are also known as tax-saving mutual funds.

Features of ELSS Funds

Here are some of the key features of an ELSS fund –

  • ELSS funds invest portfolio in equity and equity-related products.
  • ELSS funds have a mandatory lock-in period of three years from the investment date.
  • It offers dual benefits of capital appreciation from equity investments, as well as tax-saving
  • You can opt for dividend payouts to receive regular income or use the growth option for capital appreciation.
  • ELSS Mutual Funds do not have any entry or exit load.
  • Good ELSS Funds generate returns of 10-12% in the long run, the highest in the tax-saving category of instruments. 
  • Investors can invest in ELSS funds through Systematic Investment Plans (SIPs).
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How to Invest in ELSS?

Investing in ELSS is similar to any mutual fund. You can use an online investment services account as a lump sum or via the SIP route.

Here is the step-wise process of investing in ELSS –

Step 1 – Determine Your Investment Goals:

What is the purpose of your ELSS investment? Do you look for tax savings, long-term wealth creation, or a combination?

Step 2 – Choose the ELSS Fund

Research and select an ELSS fund that aligns with your investment objectives, risk tolerance, and time. Consider the fund’s historical performance, expense ratio, fund manager’s track record, and portfolio composition.

Step 3 – Choose an Investment Mode

Primarily, there are 3 modes of investing in ELSS –

  • Direct Investment: You can invest directly in ELSS funds through the fund house’s website or a designated branch.  
  • Through a Mutual Fund Distributor: Some investors still prefer to invest through a mutual fund/financial expert. These experts provide guidance and assistance with the investment process in exchange for a commission.
  • Online Platforms: Some third-party platforms offer the option to invest in ELSS funds. These platforms are convenient and allow you to compare options and choose the best.

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Step 4 – Pick A Pay-out Preference

If your chosen scheme pays dividends, select one of the two dividend options: pay-out or reinvestment. Here is how the two options work:

  • Pay-out option: In this case, the dividends are credited to your bank account. This option can be suitable if you are looking for a regular income stream from your investments. The dividend payout can serve as an additional source of cash flow.
  • Reinvestment option: In the reinvestment option, the dividends are used to buy more units under the ELSS scheme. It also helps you increase the size of your holdings and increase returns. Investors focused on long-term wealth accumulation and wanting to benefit from the power of compounding choose the reinvestment option.

Step 5 – Complete the Application Form

You must complete an application form if investing directly with the fund house or through an advisor. Provide the required details, including your personal information, investment amount, and choice of payment (lump sum or SIP).

Step 6 – Fund Your Investment

Transfer the desired investment amount to the ELSS fund’s designated bank account via online banking, a check, or other payment methods.

Note that you DO NOT need a Demat account for mutual funds.

Step 7 – Monitor Your Investment

Track the performance of your ELSS investment. Review your portfolio periodically to ensure it aligns with your financial goals.

Step 8 – Plan the Redemption and Exit Strategy

Plan your exit strategy. Once the three-year lock-in period ends, you can redeem your units if needed. Having a plan handy would help you to save time.

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Comparison of ELSS with other Tax Saving instruments

Name of Instrument Lock In period Returns Tax on Returns
ELSS 3 Years 12-14% 0 till Rs. 1 lakh10% after 1 lakh
Tax-Saving FD 5 years 4-7% Yes
National Saving Certificate (NSC) 5 years 7-8% Yes
Public Provident Fund (PPF) 15 years 7-8% Tax-exempt
National Pension System (NPS) Till retirement 8-10% Partially Taxable
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ELSS Calculation: Example

An investor Mr. A, has a taxable income of Rs 10 lakh for 2023-24 and decides to invest Rs 1.5 lakh in an ELSS fund. 

Let us check out the ELSS calculation in this case.

Calculation of Taxable Income Before ELSS Investment

Mr. A’s taxable income before the ELSS investment is Rs 10,00,000.

Calculation of Taxable Income After ELSS Investment

  1. Mr. A invests Rs 1.5 lakh in an ELSS fund.
  2. As per the Income Tax Act, Section 80C, the entire amount of Rs 1.5 lakh is eligible for a deduction from the taxable income.
  3. Therefore, Mr A’s taxable income after the ELSS investment would be:

Rs 10,00,000 (original taxable income) – Rs 1,50,000 (ELSS investment) = Rs 8,50,000.

Calculation of Tax Liability

Now, let’s calculate the tax liability based on the new taxable income of Rs 8,50,000. For this example, we’ll assume hypothetical tax slabs:

  • Up to Rs. 2.5 lakh: Nil
  • Rs. 2.5 – 5 lakh: 5% of the income exceeding Rs. 2.5 lakh
  • Rs. 5 – 10 lakh: 20% of the income exceeding Rs. 5 lakh

Tax on the income between Rs 2.5 lakh and Rs 5 lakh

=> Rs. 5,00,000 – Rs. 2,50,000 (exempted) = 2,50,000 Tax = 5% of Rs. 2,50,000 = Rs. 12,500

Tax on the income between Rs 5 lakh and Rs 8.5 lakh

=> Rs. 8,50,000 – Rs. 5,00,000 = Rs. 3,50,000 Tax = 20% of Rs. 3,50,000 = Rs. 70,000

Total Tax Liability Before Deduction

Tax on income between Rs 2.5 lakh and Rs 5 lakh + Tax on income between Rs 5 lakh and Rs 8.5 lakh 

=> Rs. 12,500 + Rs. 70,000 = Rs. 82,500

Tax Benefit Due to ELSS Investment

Mr. A’s tax liability before the ELSS investment was Rs. 82,500. After the ELSS investment, his taxable income decreased, and his new tax liability was calculated as Rs. 82,500.

Tax Payable Due to ELSS

Tax before ELSS investment – Tax after ELSS investment = Tax payable

=> Rs. 82,500 – Rs. 82,500 = Rs. 0

In this example, Mr A’s ELSS investment of Rs. 1.5 lakh reduced his taxable income, resulting in no tax payable. He effectively saved Rs. 82,500 in taxes through his ELSS investment. This is a simplified example, and actual tax calculations can vary based on individual circumstances and the prevailing tax laws.

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Who Can Invest in ELSS?

ELSS can be a good investment option for –

  • People in the early stages of careers. 
  • Individuals not earning high salaries and wanting to invest in relatively low-risk products can consider ELSS. 
  • Investors earn substantially through high-risk investments and look to save on tax.

ELSS has no age gap, so individuals can start investing as soon as they earn.  

Conclusion 

Please note that Equity Linked Saving Scheme funds offer tax benefits but do not guarantee positive returns. The performance of these funds is directly proportional to the stock market’s performance.

Investors should carefully assess their financial goals, risk tolerance, and investment horizon or approach financial/investment experts before investing in ELSS or any other mutual fund scheme. 

FAQs

How much can I invest in ELSS to avail tax benefits?

You can invest up to Rs 1.5 lakh in ELSS funds to avail tax benefits under Section 80C. This amount is eligible for a deduction from your taxable income.

What is the lock-in period for ELSS investments?

ELSS funds have a mandatory lock-in period of three years from the date of each investment. You cannot redeem or withdraw your investments during this period.

Are ELSS returns guaranteed?

No, ELSS returns are not guaranteed. They are linked to the performance of the stock market. While ELSS funds have the potential for higher returns, they also carry higher market-related risks.

Are ELSS funds suitable for long-term investments?

Yes, ELSS funds are suitable for long-term investments, and investors are encouraged to stay invested for an extended period to benefit from the power of compounding and market volatility.

Can NRIs invest in ELSS funds?

Yes, Non-Resident Indians (NRIs) can invest in ELSS funds, subject to certain conditions and compliance with Foreign Exchange Management Act (FEMA) regulations.

What are the tax implications when redeeming ELSS units?

ELSS redemptions after the three-year lock-in period are treated as long-term capital gains (LTCG). As of my last knowledge update in September 2021, LTCG from ELSS funds were taxed 10% on gains exceeding Rs 1 lakh in a financial year. Please check the latest tax regulations for any changes.

About the Author
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Rashmi Karan
Manager - Content

Rashmi is a postgraduate in Biotechnology with a flair for research-oriented work and has an experience of over 13 years in content creation and social media handling. She has a diversified writing portfolio and aim... Read Full Bio