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Tax planning is an integral part of personal finance. It’s October and people have started thinking about tax planning. Sentiments towards equity markets have also turned positive, and what better time than now to discuss tax saving mutual funds. Equity Linked Savings Scheme or ELSS is an equity diversified fund which offers investors the twin benefits of capital appreciation and tax benefits.
Salient features of ELSS:
- A diversified equity mutual fund with majority of the corpus invested in equities.
- ELSS has a lock in period of 3 years from the date of investment.
- Investment upto Rs. 1 lakh is eligible for deduction from gross total income in a financial year.
- Returns from ELSS schemes reflect returns from the equity markets.
- ELSS schemes have both growth and dividend options. Under the growth option, investors get a lump-sum only on the expiry of 3 years. Under the dividend option, investors receive a regular dividend income even during the lock-in period.
- Returns from ELSS schemes are tax-free.
Why you should choose ELSS over other tax saving instruments?
- The lock in period of ELSS is lower than other tax saving instruments like PPF (15 years), NSC (6 years) and bank fixed deposit (5 years).
- This is an investment in equity markets, and so investing in a good ELSS scheme can give you better returns compared to other asset classes over the long term
- SIP investments are possible, helping you bring about discipline in investing.
- Dividend option in ELSS helps you receive income even during the lock-in period.
What are the downsides of an ELSS?
- Since ELSS comprises of investments in stock markets, all risks associated with equity investments pertain to ELSS. If you are a risk-averse investor, it is better to avoid ELSS.
- Premature withdrawal is not possible in ELSS; instruments like PPF and bank fixed deposits allow withdrawal subject to certain conditions.
What happens to ELSS as an investment category after the introduction of DTC?
The last draft of the Direct Tax Code (DTC) has excluded ELSS as a tax saving instrument. This means that your investment in ELSS after the introduction of DTC will not qualify for tax exemption under Sec 66 (which is a replacement of Sec 80C under DTC). However, remember that this is only a draft version of the DTC. The mutual fund industry has been trying hard to include ELSS as a tax saving instrument. The final DTC may spring a positive surprise.
Popular ELSS funds in the market:
Investing in tax saving funds should involve proper research and planning, similar to any other fund. Some of the key parameters to select the right tax-saving fund include performance of the fund, the investment approach of the fund manager, the expense ratio of the fund and the volatility of the fund keeping in mind your risk-return profile. Based on 10 year performance, SBI Magnum Taxgain, HDFC Tax Saver & ICICI Prudential Tax Plan.
Investor enthusiasm towards ELSS in the previous tax planning season was subdued owing to a lack luster stock market, better returns from alternative investments in debt and the uncertainty about the status of ELSS after the implementation of the DTC. However, ELSS schemes are by far the best tax saving instruments in the long term for investors with a high risk appetite, offering better returns compared to other tax saving instruments. Let’s hope the mutual fund industry is successful in getting ELSS qualified as a tax saving instrument under DTC.
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