Tax saving is one of the most important Investment objectives of many investors. If the income earned from the investments is taxable, the potential to build wealth over long-term gets constrained as taxes will eat into your returns. ELSS is one of the few investment options available for agressive investors who’d also like to save tax.
So often people ask that which is the best available investment option for Tax saving as well as long-term wealth accumulation in the Equity Products.
When it comes to tax saving in equity, the first and the best Investment option that comes to my mind is Equity Linked Savings Scheme (ELSS).
Mostly in the tax savings instruments, the interest amount gets added to one’s income and hence is liable to be entirely taxable. Even though they help you save tax for the current year, the interest income becomes a tax liability in each year till the tenure ends. Since these come with the tax benefits, the returns on them are likely to be below than the market returns.
So for the people earning a salary or having income from business or profession, choosing tax savers that come with E-E-E status helps. The Investment in these get EEE benefit ie. exempt – exempt – exempt status on the income earned.
What are ELSS Investments?
Equity Linked savings schemes are diversified equity mutual funds with two differentiating features
- Investment amount in them qualifies for tax benefit under section 80 c of the Income-tax Act 1961, up to a limit of Rs. 1.5 lac a year. There is no upper limit for Investment in ELSS.
- The amount invested has a lock-in period of 3 years, the lowest among all the tax saving options available under section 80C. The returns in ELSS are not fixed and neither assured but is dependent on the performance of equity markets thus giving you a better chance to get better Inflation-adjusted returns. Investors can opt for dividend option and can get regular income even during the lock-in Period. After the lock-in ends, one may continue with the ELSS investments similar to any open-ended MF Scheme. However, review its performance against its benchmark before doing so.
Comparing the opted Tax savings schemes
|S. No.||Savings Scheme||Lock In period||Tax on Maturity||Tax on Interest/ Dividend||SIP Available|
|1||ELSS||3 Years||Tax free||Tax free||Yes|
|2||PPF||15 Years||Tax-free||Tax free||Yes|
|4||Tax Saver FD||5 Years||Taxable||Taxable||No|
* Assumed reinvested with the capital, but if you invested to the full limit of 80C it is taxable.
Before you invest in ELSS
- Have a Financial Goal: Be it owning a home, funding children education or saving for retirement – know what you are saving for. Next, figure out a rough estimate ( no one can know the exact amount, of course) and set a timeline for each goal. Decide on the periodic payment based on this.
- Choose Wisely: Study the market and understand the variation trends, which cannot be done overnight. You can rely on a financial advisor, a distributor or a reputed fund house for this. Do not consider performance alone as other invisible parameters like market fluctuations and consistency of the fund also come into play.
As ELSS is an equity oriented scheme with more than 65 % of allocation into equities (in practice, it is 80 percent or more) the long-term capital gains tax on them is nil. Further, the dividends in an equity scheme are tax-free. Hence, investing in ELSS Yield tax-free income both for the dividend and the growth unitholders.
What makes ELSS income Tax free
Dividend in an ELSS should not be construed as similar to the dividend received from an equity share. In the latter, the dividend is declared out of profits generated by a company while in MF, it is out of the NAV. For an MF unitholder, receiving a dividend is merely equal to the redemption of units.
Dividends in ELSS
Kindly note that‘ Tax Saving‘ is just one aspect of ELSS Investments. Wealth Creation should also be an equally important objective. The key to Equity Investment is to remain invested for a sufficiently long-term horizon of at least 5-7 years.