Understanding ELSS Mutual Funds: A Smart Way to Save Tax and Grow Wealth

Investors constantly seek out investments that can offer good returns, generate wealth, and/or save taxes. Among the various investment options available, ELSS (Equity-Linked Savings Schemes) funds strike the perfect balance between good returns and tax-savings. These tax-efficient mutual fund schemes offer good tax benefits to investors along with the possibility of high equity-linked returns. This article discusses what are ELSS funds, their meaning, benefits, and suitability to help you understand why they have gained traction among tax-focused investors.

Let’s start with the meaning of ELSS funds. Equity-linked savings schemes or ELSS funds primarily invest in equity and equity-related assets. ELSS funds are tax-efficient equity funds that offer annual tax deductions of up to Rs. 1.5 Lakhs under Section 80(C) of the Income Tax Act, 1961. Therefore, you can consider ELSS funds if you’re looking to invest in mutual funds to add tax-saving instruments to your portfolio.

Here’s a quick overview of the features of ELSS funds:

• ELSS funds come with a minimum lock-in duration of 3 years.

• At least 80% of the fund’s corpus is invested in equities.

• ELSS investments qualify for tax deductions of up to Rs. 1.5 Lakhs u/s 80(C).

• Investors earn market-linked returns which depends on the performance of the fund’s underlying assets.

• Capital gains from ELSS funds are not tax-free. A 12.5% Long-Term Capital Gains (LTCG) tax is applicable on gains above Rs. 1.25 Lakhs.

Now that you know what ELSS funds are, let’s move on to how they operate. ELSS funds pool money from multiple investors to invest in a diversified equity portfolio. These funds primarily invest in stocks of publicly-traded companies belonging to various market capitalisations and industries. The fund manager picks the stocks depending on the investment objective and approach of the mutual fund scheme to ensure the best risk-adjusted returns for the investors.
 

ELSS fund investments are tax deductible up to Rs. 1.5 Lakhs u/s 80(C) of the Income Tax Act. This means if you invest Rs. 50,000 into an ELSS fund in a given year, then this amount will be deducted from your total taxable income, reducing your income tax liabilities for the given fiscal year. However, you should note that there is no limit to how much you can invest in ELSS funds. This limit is only for the amount eligible for tax exemption. Additionally, the funds invested in ELSS mutual funds remain locked in for a period of 3 years.

With the meaning of ELSS funds clear, it’s quite obvious why you should invest in ELSS funds. However, if you’re still not convinced, here’s a list of ELSS fund benefits you can review:

• Tax benefits: One of the chief benefits of ELSS investments is the tax deductions available with the scheme. ELSS mutual fund schemes offer tax deductions u/s 80(C) up to a maximum of Rs. 1. 5 Lakhs. Therefore, you can invest in ELSS funds to lower your outstanding tax liabilities and leverage high returns.

• Diversification: Most ELSS funds invest in a wide range of companies, ranging from small-cap to large-cap firms. These funds also diversify across industries and sectors to offer good diversification and risk mitigating benefits to your portfolio. In short, investing in ELSS funds allows you to diversify equity investments with just one scheme.

• Low minimum investment: Investors can start SIPs in popular ELSS funds with as little as Rs. 500. This low minimum investment benefit of ELSS funds allows investors to start with small contributions rather than waiting to invest once they have a lump-sum ready.

• ELSS funds invest 80% of their corpus in a diversified basket of equities.

• Investors can claim a tax deduction of up to Rs. 1.5 Lakhs on ELSS investments in a given year.

• ELSS funds are best-suited for salaried employees and first-time investors.

Before you invest in ELSS funds, it’s essential to understand the tax implications of your investment thoroughly. Let’s understand the taxation impact of ELSS funds:

• The principal invested in ELSS funds qualifies for 80(C) deductions. However, this is a cumulative benefit, meaning you can claim a deduction of up to Rs. 1.5 Lakhs under this section for all qualifying investments made in instruments like PPF, NPS, and tax-saver FDs.

• Since ELSS funds have a lock-in period of 3 years, the units of the fund can only be sold after the lapse of this lock-in window. In other words, gains from the sale of ELSS fund units attract a long-term capital gains (LTCG) tax at 12.5%.

• No LTCG tax is applicable if capital gains are less than Rs. 1.25 Lakhs in a given year.

The following category of investors can make the most out of ELSS fund benefits:

Young investors: ELSS funds are well-suited for young investors with a long-term investment horizon who are willing to take on higher risks for better returns. Young investors can leverage the growth potential of equities over the long-run to build a sizable corpus.

Salaried employees: Salaried employees with a stable and regular income stream looking to reduce tax liabilities can opt for ELSS funds. They can conveniently contribute to ELSS funds via affordable monthly SIPs.

Investors without liquidity issues: ELSS funds are ideal for investors who do not have liquidity concerns, as the money deposited is locked-in for 3 years. It is important to note that this 3-year mandatory lock-in window is applicable to each SIP contribution separately.

In summation, ELSS funds are the only mutual fund category that offers tax benefits to investors under Section 80(C). Investors can leverage the dual benefits of ELSS funds to earn high returns and save on taxes. While ELSS funds are best-suited for young investors with a long investment horizon and high risk appetite, even investors who have 7-8 years left before retirement can consider these tax-saving instruments.
 

Want to invest in the best ELSS funds? Head to the Bajaj Finance Mutual Fund Platform where you can compare mutual funds, review past returns, and start SIPs in a jiffy. Leverage our state-of-the-art Mutual Fund Calculator tool to estimate returns from ELSS investments to see if they fit into your financial plan.