Equity Linked Saving Scheme (ELSS)

Equity Linked Savings Scheme, commonly known as ELSS, is a diversified, open-ended, equity-oriented mutual fund scheme. In ELSS, 80% of the portfolio amount is required to be invested in equity funds with a minimum lock-in period of 3 years from the date of allotment of units. In the recent time, ELSS has become one of the most popular tax-saving options.

Benefits of Investing in ELSS

1) Tax Benefit

An individual or HUF can claim a deduction from total income of up to Rs. 1.5 lacs under Section 80C of Income Tax Act, 1961.

Tax saving for a resident individual having an age of less than 60 years for the FY 2018-19

Total Taxable Income before ELSS investment Amount Invested in ELSS under Section 80C Tax before ELSS Investment Tax After ELSS Investment Total Tax Saving*
5,00,000 1,50,000 13,000 2,600 10,400**
8,00,000 1,50,000 75,400 44,200 31,200
10,00,000 1,50,000 1,17,000 85,800 31,200
15,00,000 1,50,000 2,73,000 2,26,200 46,800

* Including 4% health and education cess.

** After considering Rs 2,500 rebate under section 87A of the Income Tax Act, 1961

ELSS also known as tax saving mutual funds fall under EEE (Exempt-Exempt-Exempt) status. EEE status means the amount invested, income earned and maturity proceedings are exempt from income tax.

  • Amount Invested – Deduction up to Rs. 1.5 lacs under section 80C of the Income Tax Act, 1961
  • Income Earned – Dividend received from ELSS are exempt from tax under section 10(35) of the Income Tax Act, 1961
  • Maturity Proceedings – Long-term capital gain (net sales proceeds – investment amount) up to an amount of Rs. 1 lac is exempt from tax under section 112A of the Income Tax Act, 1961. The gain in excess of Rs 1,00,000 is chargeable to tax at a flat rate of 10%.

2) Minimum lock-in period

ELSS schemes have a lock-in period of three years from the date of allotment of units. After the expiration of this lock-in period, these units can be redeemed or switched. During the lock-in period, investors cannot sell, redeem, pledge, transfer, or in any manner alter their holding in the fund.

ELSS scheme has the lowest lock-in period in comparison with the other investment options available for 80C deduction. Such as PPF have a lock-in period of 15 years, NSC investments have 6 years, and bank fixed deposits eligible for tax deduction are locked in for 5 years.

3) Higher Rate of Return

A major portion, minimum 80% of the portfolio amount, of the fund is required to be invested into equities and thus provides higher returns as compared to other instruments. Generally, they give superior returns (14-16%) compared to other tax-saving options in the long period (5-7 years).

You cannot ignore the element of risk as all the ELSS schemes are equity-based and market linked. However, AMC’s design of their scheme on the basis of large-cap, mid-cap, and small-cap and accordingly their risk and returns varies. Therefore, the schemes provide you flexibility in taking the risk while investing.

4) A Choice between Dividend and Growth Option

The investor can select either dividend or growth option at the time of making the investment in ELSS scheme.

  • Dividend Option – In the dividend option, investors get a regular dividend income whenever a dividend is declared by the fund, even during the lock-in period. Such dividend payout is tax-free in the hands of the investor. Dividend payout depends upon the profits and approval of the scheme from the board. It means if there is no profit, the company is not bound to pay any dividend.
  • Growth Option – In growth option, the investor cannot get any return during lock-in period. Every year incomes will be accumulated to your investment and re-invested.

Both of the above options will provide the same return. The dividend is paid from the Net Asset Value of the scheme which will result in the fall of the NAV at the end of lock-in period.

So, in ELSS, the investor has a choice to opt for dividend option and if the fund declares a dividend payout, the investor can get access to such profits even during the 3 year lock-in period. Such an option is not available in any other investment scheme under Section 80C.

5) Flexible and Disciple

Investment in ELSS scheme can be done using

  • Lump sum amount – Full investment in single time, or
  • SIP (Systematic Investment Plan) – Small investments spread over a period of time.

There is no restriction on the maximum amount which can be invested in ELSS. However, you can start investing in ELSS funds at a low starting amount of just Rs. 500. With the availability of monthly investments, you can get disciplined with your investment and tax planning. Generally, it is recommended to follow the SIP route as it spreads your investment over a longer duration and also avoids the risk of downside market peaks.

6) High Level of Transparency

You can track the changes in your portfolio value on a regular basis. Access to this information helps in making more educated decisions regarding the overall return from your diversified portfolio. This level of transparency is not available in case of any other tax saving investment option.

7) Dual tax benefit: As highlighted before, the amount investe into ELSS qualifies for deduction upto limits specified under Section 80C. But, even the profit/capital gain earned from the ELSS Scheme is completely tax-free. If one sees a return from National Savings Certificates or tax saving bank FDs, they are completely taxable and added to the income. Only PPF offers the tax-free return, but it has a maturity period of 15 years.

Also Read – Capital Gain on sale of Equity Shares – LTCG & STCG

Concerns Regarding ELSS

Few things which are required to be considered before making an investment under ELSS scheme i.e.

1) Inherent Risk

ELSS scheme invest funds in the equitystock market. So, all the risks associated with equity investments pertain to ELSS.

2) No premature withdraw

You cannot withdraw your funds before the lock-in period of 3 years. Other instruments like PPF and bank deposits permit premature withdrawal, subject to certain conditions.

3) Selection of Scheme

Lots of ELSS scheme are available in the market. Before investing, you should do a thorough background check of the ELSS fund and its performance before making a decision to invest. This check is very much similar to the check done before investing in another general mutual fund such as: –

  • Comparison of performance of the scheme vis-a-vis its benchmark index, category and peers. Good performance in one or two years does not makes a great fund to invest in. You should pick a scheme which a very good long-term return record at least for a period of 7-10 years.
  • Asset under management is the total market value of assets that is being managed by funds. Investor should look for funds which have high AUM as this generally have a low expense ratio. Low AUM in any scheme is considered risky as you don’t know the quantum of investment made by each investor. Exit of any big investor out of low AUM scheme may impact overall performance and remaining investors of the scheme have to bear this impact.
  • Investor should look for ample diversification. If the fund is not diversified and focused only on single sector then your investment may hit hard when there is no growth or saturation in that sector
  • Low Expense Ratio – Expense ratio is the percentage of total assets that are spent to run a mutual fund. Expense ratio states how much charges you will pay for managing your money. Since this is charge every year, a high expense ratio may eat a big portion of the return through the power of compounding.

Comparison between PPF, NSC and ELSS

Particulars PPF NSC ELSS
Tenure 15 years 6 years Not fixed
Returns 8% to 8.5% 8.50% to 8.80% Return/Loss are market linked
Risk Negligible Risk Negligible Risk Medium to High Risk
Tax on Returns Tax free Taxable Tax free
Minimum Investment Rs. 500 Rs. 100 Rs. 500
Maximum Investment Rs. 1,50,000 No limit No limit
Lock in period 15 years – Partial withdrawal
after 6 years is permitted
6 Years 3 years

Also Read – Everything about Public Provident Fund (PPF)

[Photo credit: Got Credit]

Rohit Pithisaria

Rohit Pithisaria

I am a Chartered Accountant based in Jaipur (Rajasthan). Started TaxAdda in 2011 as a blog and now providing various services related to GST and Income Tax to the client all over India.

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