Understand the differences between Equity-Linked Savings Schemes (ELSS) and Systematic Investment Plans (SIPs) for tax-efficient wealth creation.
3 min

While looking into Mutual Fund investing, you might come across a few terms such as Equity Linked Savings Scheme (ELSS) and Systematic Investment Plan (SIP). ELSS represents a specific type of mutual fund offering tax benefits, while SIP is a strategy to invest in mutual funds, including ELSS, in a disciplined manner. This guide dives deep into  ELSS vs SIP, simplifying the difference between ELSS and mutual funds for investors.

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.