ELSS mutual funds are about tax exemption

Equity Linked Savings Schemes (ELSS) are a type of diversified equity funds, with additional tax benefits under Section 80C of the Income Tax Act. These funds are popularly known as ELSS Mutual Funds or Tax Saving Funds.

Here is how the ELSS exemption works. There is a blanket exemption of Rs 1.50 lakhs under Section 80C of the Income Tax Act and contributions to the ELSS is part of this limit. You can either contribute the entire Rs 1.50 lakhs to ELSS mutual funds, or you can make the ELSS contribution as part of the overall contribution, which includes employee PF, life insurance premium, PPF, NSC, home loan principal repayment, long-term bank FDs, etc. Either way, your overall exemption under Sec 80C per financial year cannot exceed Rs1.50 lakhs.

Remember, ELSS mutual funds are just like any other diversified equity funds. For all investments done in this category of schemes, there is a lock-in of 3 years, and investors can claim deduction under Sec 80C of income tax. Investments in ELSS mutual funds can be done through either SIP or Lumpsum mode. In case of SIPs, each SIP instalment will be locked in for a period of 3 years from the SIP date.

How have ELSS funds performed in India?

ELSS funds manage about Rs.1,88,033 crores in India as per the AMFI data reported as of November 2023 end. That is a substantial AUM and this is largely from investors looking to save tax through the Section 80C route and to create wealth.

Apart from wealth creation, the real big return booster in ELSS mutual funds is the tax benefit. Since Section 80C is an exemption, it reduces your taxable income by the amount of contribution to ELSS funds, subject to an overall limit of Rs 1.50 lakhs per financial year.

How much Tax can I save by investing in ELSS funds?

You can save tax up to Rs. 46,800 per year by investing in ELSS funds if, say, you invest Rs 1,50,000 and you fall in the highest tax bracket of 30%.

Note that there is no limit to the amount you can invest in ELSS mutual funds. The limit is only for the amount that is eligible for income tax deduction.

For e.g., you can invest Rs 2,00,000 in ELSS funds, but the tax exemption is capped at Rs 1,50,000; meaning no deduction can be availed for the remaining amount of Rs. 50,000.

The total benefit will depend on the tax bracket that the investor in ELSS is in.

Benefits of investing in ELSS funds

Here are some of the key advantages of investing in ELSS Mutual Funds.

1. ELSS mutual funds are a great product to onboard first-time equity investors. Even if you are not a compulsive equity investor, you need to save tax. ELSS is like hitting two birds with one stone. It saves tax and also introduces you to the benefits of long term equity investing and wealth creation. ELSS is a good way to start your equity journey as the lock-in prevents panic/emotional selling during turmoil.
   
   
2. If you compare the ELSS mutual funds with other Section 80C products, then ELSS has the lowest lock-in period at 3 years. In comparison, Public Provident Fund (PPF) or National Savings Certificate (NSC) are locked in for 7 years to 15 years. Even long-term bank FDs and ULIPs have a mandatory lock-in period of 5 years. Relatively, the lock-in of 3 years on ELSS mutual funds is the lowest.
   
   
3. ELSS mutual funds are also flexible. You can invest as lumpsum or use the SIP option. If you are looking at regular tax saving, ELSS SIP is a good choice as it also instils tax saving discipline. Also, you can start small and then grow the amount gradually.
   
   
4. ELSS mutual funds are natural wealth generators because they are invested in equity and they are necessarily held for the long term (at least 3 years); and this somewhat contributes to better returns compared to debt funds and balanced funds.
   
   
5. You cannot talk about ELSS and not refer to the tax benefits. The exemption can even go slightly above 30%, depending on your tax bracket.

A word on the New Tax Regime

Finally, here is one word of caution on ELSS mutual funds. If you opt for the New Tax Regime (NTR) effective from this Financial Year 2023-24, then benefits under Section 80C are not available but you can still invest in ELSS for wealth creation.

Disclaimer: Mutual fund investments are subject to market risk, read all scheme-related documents carefully and consult with your advisor or tax consultant before investing.