Last Updated on Feb 13, 2023 by Anjali Chourasiya
Tax saving season is here. We all want to ensure that we can minimise our taxes, at the same time, select such investment products which also optimise our returns.
One such investment product is Equity Linked Savings Scheme (ELSS), also known as tax-saving mutual funds. Is this the most suitable tax-saving product for you?
Let’s break it down and analyse.
Table of Contents
But first, what is ELSS?
ELSS are equity mutual funds which invest more than 80% of their funds in stocks – across large-cap, mid-cap and small-cap.
They come with a lock-in period of 3 yrs from the date of investment, one of the shortest lock-in products with tax benefits. Other investment products eligible for a tax deduction, like life insurance premiums, Public Provident Fund (PPF), and tax-saving bank deposits, come with a minimum of the 5-yr lock-in period.
The amount invested in these mutual funds is eligible for tax deduction under Section 80C, i.e. up to Rs. 1.5 Lakh per year, i.e. ~Rs. 46,800 savings in tax.
What about the returns?
Since ELSS funds invest in stocks – the returns are not guaranteed.
However, if we consider the historical performance, the annual average return of the category has been:
Over 3 yrs: 14.75% per annum
Over 5 yrs: 9.12% per annum
Over 10 yrs: 13.83% per annum
Comparing these to the other traditional tax-saving options, like PPF, NSC (National Savings Certificate), etc., it is evident that ELSS funds offer far superior returns.
What are the risks involved?
However, these returns come with certain risks, which one should be aware of.
ELSS funds do not offer guaranteed returns – the returns are closely linked to stock market performance. In the short term, their returns could also be negative. For instance, the average returns of ELSS in the last 1 yr are -0.13%. Hence, these are suitable for those with a long-term investing horizon and the risk profile to handle the ups and downs.
Who should choose ELSS funds?
Equity-linked savings schemes make for suitable investments for tax-saving for those with
- First-time equity investor – If you have been keen to start investing in equities but not sure yet, ELSS funds are the most appropriate investment. Why? Since these have a compulsory lock-in period, first-time investors become aware and comfortable with facing the regular ups and downs, which are a part of equity investment.
- High-risk appetite – If you want to diversify beyond fixed-income products and are willing to take higher risks, consider allocating a small amount towards these funds under the Rs. 1.5 lakh bracket.
- Long-term focus – Consider ELSS funds for long-term goals beyond 5 yrs. This would minimise risk and maximise the power of compounding. An investment of Rs. 1,00,000 in ELSS funds could become approx. Rs. 1,45,000 in 3 yrs (13% annualised return).
3 less-known facts to remember before investing
- Taxable on maturity
While the investment amount is considered for a tax deduction, once you sell the fund, if there is any profit, it will be taxed under Capital Gains tax. Current income tax rules state that no tax is payable up to Rs. 1 lakh of profits. More than Rs. 1 lakh of profits, flat 10% tax payable on the remaining amount.
For example, Kavita invests Rs. 1.5 lakh in ELSS to claim the entire amount as tax deduction under 80C. After 3 yrs, she decides to sell all the units of the fund whose value has increased to Rs. 3.2 lakh.
Her capital gains amount = Rs. 3.2 lakh – 1.5 lakh i.e., Rs. 1.7 lac.
Since the amount is more than Rs. 1 lakh, she is liable to pay tax on this profit, as follows:
| Amount of profit | Tax Payable |
| Up to Rs. 1 lakh | 0 |
| Remaining Rs. 70,000 (1.7L – 1L) | Rs. 7,000 (10% x 70,000) |
| Total capital gains tax payable | Rs. 7,000 |
- Lock-in but no fixed maturity date
Don’t confuse lock-in with maturity. ELSS funds cannot be redeemed (sold) during the 3-yr lock-in period. However, after 3 yrs, one can continue to hold these investments. They don’t have a fixed maturity date and shall not automatically be credited into your account like fixed deposits or insurance policies. After 3 yrs, one can consider them as any other mutual fund investment that can be redeemed fully or partially, per requirement. We recommend holding on to these funds over a long-term horizon.
- Each SIP counts
It is recommended to invest in equity funds through the SIP (Systematic Investment Plan) route. However, while investing in ELSS funds, please remember that the lock-in period of 3 yrs is counted from each SIP investment date; not from the date of the first SIP investment.
Example: If Ratna starts a SIP in XYZ ELSS fund of Rs. 10,000 per month from 1st January 2023 – her lock-in for each SIP will end as per the below schedule:
| Date of Investment | End of lock-in period |
| 1 January 2023 | 2 January 2026 |
| 1 February 2023 | 2 February 2026 |
| 1 March 2023 | 2 March 2026 |
| 1 April 2023 | 2 April 2026 |
So, while she can withdraw all units invested in January 2023 on January 2026 – but she will need to wait till April 2026, if she wants to redeem all the units invested till April 2023.
These lock-in dates must be kept in mind while planning for goals through ELSS.
Conclusion
Investing for saving taxes should not be seen in isolation. When one selects investment options which fit into their overall financial plan while helping in tax optimisation, that’s a win-win investment strategy.
You can use Tickertape Mutual Fund Screener to get the list of ELSS funds in India. Launch the Mutual Fund Screener, search for ELSS under ‘category’ and use 50+ filters like AUM, NAV, expense ratio, etc., to sort them and find the best one.
Neha has over 14 years of corporate experience in financial services and strategy consulting with companies like Standard Chartered Bank, Kotak Mahindra Bank, Deloitte India and MakeMyTrip.
Combining her passion with her knowledge and experience, Neha founded Womoneysta in 2020. She recently got recognized as LinkedIn's Top Voice for Gender Equity 2022. She is a TEDX speaker and is also empanelled as faculty with NSE Academy.
- Should You Invest in ELSS Funds To Save Taxes? - Feb 8, 2023
