Mutual Fund ELSS schemes : Best way to Save Tax and Create Wealth
As recent as a few months back, more than one person told me that they would not have invested in life insurance policies for tax saving if they knew more about the return potential of Equity Linked Savings Schemes (ELSS). Despite considerable efforts made by the mutual fund industry on investor awareness over the years, the average person’s knowledge of mutual fund products is still quite low even in large urban centres.
Investments in Equity Linked Savings Schemes are exempt from taxes under Section 80C of Income Tax Act 1961. By investing up to Rs 150,000 (maximum allowable investment under Section 80C), investors can save up to Rs 46,350 in taxes.
There is no taxation during the investment tenure in Equity Linked Savings Schemes, unlike say bank fixed deposit, where the investor has to pay tax on the interest earned. Dividends paid by Equity Linked Savings Schemes are also tax free.
The redemption amount of Equity Linked Savings scheme is also entirely tax free. Equity Linked Savings Schemes have a lock-in period of 3 years. Since investors have to remain invested for three years, there is no incidence of short term capital gains tax. Long term capital gains in Equity Linked Savings Schemes are tax free.
As such, in taxation parlance, Equity Linked Savings Schemes are exempt – exempt – exempt investments. They are exempt from taxes at the time investment, during the tenure of investment and also at the time of redemption.
Equity Linked Savings Schemes have a lock-in period of 3 years. If you are investing in ELSS through systematic investment plan (SIP), each SIP installment will be locked- in for three years. Most Section 80C investment options, other than ELSS, have a minimum lock-in period of 5 years.The dividend option of Equity Linked Savings Schemes(ELSS) provides investors with the option of getting tax free income from their ELSS investment during the lock-in period and beyond. Investors should however note that mutual fund dividends are paid at the discretion of the scheme’s fund manager. There is no assurance with regards to timing or amount of dividends paid by mutual funds.
Equity as an Asset Class
Equity Linked Savings Schemes invest in diversified portfolio of stocks across different sectors and market capitalization segments. Though ELSS investments are subject to equity market risks, equities have been the best performing (in terms of returns) asset class in the long term. Rs 1 lakh invested in the Sensex 20 years back would have grown to Rs 7.8 lakhs, while the same amount invested in gold and fixed deposit would have grown to Rs 5.2 lakhs and Rs 4.4 lakhs respectively.
Mutual fund offers investors the benefit and convenience of disciplined investing through Systematic Investment Plan (SIP). By providing an ECS mandate, a fixed amount on a fixed date gets debited automatically from your bank account every month (or any other frequency) and gets invested in the mutual fund scheme of your choice. Through an SIP in ELSS or Tax Saver Funds, you will not only be able to meet your tax saving needs for the financial year, but also, over a sufficiently long period of time, create wealth through disciplined investing. SIPs take advantage of the volatility in stock markets, through rupee cost averaging generating superior returns for investors in the long term.
You can see that, with a monthly SIP of just Rs 5,000 you can accumulate a corpus of around Rs 14 lakhs in 10 years and a corpus of Rs 75 lakhs in 20 years, assuming a return of 15%. The maximum benefits of the equity investing are seen over a long investment horizon (the longer the better). Therefore, in our view, even though Equity Linked Savings Schemes have a lock-in period of just 3 years, investors should plan on remaining invested much longer. ELSS investments are suitable for tax saving and long term investment objectives like children’s higher education, children’s wedding, retirement planning or simply wealth creation.