ELSS vs SIP

ELSS offers tax benefits and wealth accumulation with a mandatory 3-year lock-in period. In contrast, SIP allows investors to regularly invest small amounts into mutual funds, serving as a disciplined method to build a diversified investment portfolio over time.
Difference Between ELSS and SIP
3 min
13-November-2024

Equity-Linked Savings Schemes (ELSS) and Systematic Investment Plans (SIPs) are among the most common terms you will come across when investing in mutual funds. However, they serve different purposes and can't be directly compared. ELSS is a type of mutual fund that primarily invests in equities and offers tax benefits under Section 80C of the Income Tax Act. On the other hand, SIP is a method of investing in mutual funds, including ELSS. Following this method, you gradually invest a fixed amount regularly rather than a lump sum.

In this article, we will understand ELSS vs. SIP in detail by studying their several features, benefits, and key differences.

Difference between Features of ELSS and SIP

1. SIP as an investment avenue in ELSS

  • While ELSS is a mutual fund category aimed at saving taxes, SIP is a methodical approach to investing in mutual funds, including ELSS. The distinction is clear: one is a product, the other a process. Through SIP investments, investors can commit a fixed amount regularly – be it weekly, monthly, or annually – towards investing in mutual fund schemes, ELSS included.
  • Investment flexibility: Starting with as low as Rs. 100 per month, SIPs offer an accessible route to mutual fund investment, including the tax-saving ELSS funds.

2. Lock-in period considerations

  • Understanding lock-in: The concept of a lock-in period is pertinent to ELSS, not SIPs. ELSS funds mandate a lock-in period of three years, during which investors cannot withdraw their investment. Conversely, SIPs, as a mode of investment, do not inherently possess a lock-in period; however, if invested in an ELSS fund, each SIP instalment adheres to a separate three-year lock-in from its investment date.

Difference between Advantages of ELSS and SIP

ELSS benefits:

  • Tax savings: Unique to ELSS funds, investors enjoy tax deductions under Section 80C up to Rs. 1,50,000. (Also, read about the income tax slabs of FY 2024-25 for more details around taxation).This tax benefit, exclusive to ELSS within the mutual fund universe, allows investors to reduce their taxable income by the amount invested in ELSS funds, regardless of whether through SIP or a lump sum investment.

SIP advantages:

  • Disciplined investing: SIPs facilitate a disciplined approach to investing, allowing participants to build a substantial corpus over time through regular, small investments. This method is especially beneficial for long-term financial goals, offering flexibility and ease of investment.

Frequently asked questions

What is the upper limit of tax deduction one can avail through investment in ELSS under the Indian tax laws?

Investing in Equity Linked Saving Schemes (ELSS) can significantly benefit taxpayers looking to reduce their taxable income. According to the provisions of Section 80C of the Income Tax Act, 1961, an individual can claim a deduction up to a limit of Rs. 1,50,000 from their total income. This feature makes ELSS a preferred vehicle for tax-saving investments, offering a dual advantage of tax deduction and potential for high returns through equity exposure.

How does the redemption process work for ELSS investments made via SIP, considering the lock-in period?

For investors who opt for Systematic Investment Plans (SIPs) as a mode of investment in ELSS funds, the redemption process is strategically organised. Given the compulsory lock-in period of three years for ELSS investments, the units are redeemed in a sequential manner, following the first-in, first-out (FIFO) method. This means that the units that were bought earliest are redeemed first, once they complete the lock-in duration. This orderly process ensures that the investments are systematically locked in for the required period, aligning with the long-term investment horizon of ELSS funds.

What are the tax implications for the redemption of ELSS fund investments?

While ELSS funds stand out for their upfront tax deduction benefit under Section 80C of the Income Tax Act, they do entail tax implications at the time of redemption. The gains from ELSS, classified as long-term capital gains (LTCG), are not entirely tax-exempt at withdrawal. Investors are granted a tax exemption on LTCG up to Rs. 1,00,000 per annum. Any gains beyond this threshold are taxable at a rate of 10%. Despite this tax on higher gains, the favourable exemption limit ensures that the tax impact on returns is minimised, maintaining ELSS as an appealing option for investors aiming for tax-efficient growth over time.

Is SIP good for ELSS?

Yes, SIPs are a good method for investing in ELSS funds. ELSS is the only type of mutual fund that offers tax savings under Section 80C of the Income Tax Act. Using SIPs to invest in ELSS allows you to invest small amounts regularly. Such a gradual investing avoids the need for a large initial investment. Moreover, this approach reduces the risk of market timing since you invest consistently over time. It helps you take advantage of market fluctuations by averaging out the cost of your investments.

How do I know if my SIP is ELSS?

To determine if your SIP mutual fund is an ELSS, you need to verify its classification. Be aware that ELSS (Equity-Linked Savings Scheme) is a type of mutual fund that provides tax deductions under Section 80C of the Income Tax Act, 1961. You can confirm this by checking the fund details on the fund house’s website. Look for information indicating that the fund is categorised as an ELSS. Mostly, this is highlighted due to its tax-saving benefits.

Is ELSS SIP tax-free?

ELSS SIP investments are not entirely tax-free but offer significant tax advantages. When investing in ELSS mutual funds, you get a deduction up to Rs. 1,50,000 under Section 80C. Now, once invested, you have to serve the mandatory three-year lock-in period. This implies you can only earn long-term gains when redeeming the units of ELSS funds.

After the latest changes in the Union Budget 2024, these gains are tax-free up to Rs. 1.25 lakh per year (up from the erstwhile limit of Rs. 1,00,000). Any earnings beyond this threshold are subject to a 12.5% long-term capital gains tax (up from the previous tax rate of 10%).

Hence, ELSS is an attractive option for tax-saving while investing in equity markets, but it's important to be aware of the tax implications at the time of redemption.

Is lump sum better than SIP for ELSS?

Whether to invest in ELSS through a lump sum or SIP depends on your timing and purpose. A lump sum investment is preferred if you need to save tax at the end of the financial year. However, if you're investing at the beginning of the financial year, you can choose between a lump sum or SIP option. Be aware that both methods provide the tax benefits of ELSS and the growth potential of equities.

Is NPS better than ELSS?

It is worth mentioning that comparing between NPS and ELSS depends on your investment goals. ELSS offers more control and flexibility. It allows you to choose from various funds based on your risk tolerance and financial goals. NPS, while also flexible, has restrictions on withdrawals and requires annuity purchases. It specifically focuses on long-term retirement planning.

Hence, ELSS is ideal for those seeking equity growth and tax benefits with more liquidity, whereas NPS is better suited for disciplined long-term retirement savings. Both types of investments offer deductions under Chapter VI-A of the Income Tax Act.

What are the disadvantages of ELSS?

ELSS funds carry higher risk as they are linked to the equity market and subject to market volatility. Due to a mandatory 3-year lock-in period, they have limited liquidity and are not suitable for risk-averse investors who prefer safer options like life insurance or PPF.

Additionally, the tax benefits are limited to Rs. 1.5 lakhs per financial year (available under Section 80C of the Income Tax Act), even if you invest more. Moreover, ELSS funds have management costs. They are professionally managed and, hence, you are required to pay a fee for the fund manager's expertise.

Is ELSS maturity tax-free?

ELSS maturity is not entirely tax-free. Only long-term capital gains (LTCG) can arise at the time of redemption of ELSS funds (due to a 3-year lock-in period) that are exempt up to Rs. 1,25,000 per year (limit increased in Union Budget 2024 from the previous Rs. 1,00,000 per financial year). Any gains above this limit are subject to a 12.5% LTCG tax (up from the previous 10% tax rate) plus applicable cess and surcharge.

This tax treatment makes ELSS an attractive option for tax saving and investment. However, it must be noted that while initial gains are exempt (if they fall within the limit of Rs. 1,25,000), larger profits exceeding the stipulated threshold will incur a tax.

Are ELSS and SIP the same?

“ELSS” and “SIP” are common terms used while investing in mutual funds but completely differ in meaning and function. ELSS (Equity-Linked Savings Scheme) is a type of mutual fund that offers tax benefits under Section 80C. It specialises in equity investments and has a mandatory 3-year lock-in period. On the other hand, SIP (Systematic Investment Plan), is a method of investing, where you contribute a fixed amount regularly. SIPs can be used to invest in ELSS and other types of mutual funds. So, ELSS is a fund type, while SIP is an investment approach or mode of investment.

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Bajaj Finance Limited (“BFL”) is an NBFC offering loans, deposits and third-party wealth management products.

The information contained in this article is for general informational purposes only and does not constitute any financial advice. The content herein has been prepared by BFL on the basis of publicly available information, internal sources and other third-party sources believed to be reliable. However, BFL cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. 

This information should not be relied upon as the sole basis for any investment decisions. Hence, User is advised to independently exercise diligence by verifying complete information, including by consulting independent financial experts, if any, and the investor shall be the sole owner of the decision taken, if any, about suitability of the same.