Now that the financial year is coming to an end, it is time to start tax planning. One of the options for tax planning is the equity-linked saving scheme (ELSS). Investments in ELSS are eligible for tax benefit. The maximum amount that can be invested is Rs 1 lakh during a year. ELSS funds invest in equities.
An investment in ELSS is locked-in for three years. As against this, investments in the national savings certificate (NSC) is locked-in for six years, and in public provident fund (PPF) scheme the lock-in period is 15 years.
It is to be noted that the returns on ELSS are linked to the performance of the stock markets. As against this, the returns on NSC and PPF are guaranteed. The present rate of interest is fixed at eight percent on NSC and PPF.
The dividend income from an ELSS schemes is tax-free. The sale proceeds on sale are exempt from long-term capital gains tax too. As against this, the interest on NSC is taxable. The interest earned on PPF however is tax-free. The income is taxable in case of NSC interest.
After a certain point in time, an ELSS can be used to meet expenses. In case of need, you can sell the units that have been held for three years from the date of allotment. The sale proceeds, which are exempt from tax, can be reinvested in the same scheme too. As there is no entry load, the investor will not lose if he invests the funds immediately.
You can get a tax exemption on a maximum amount of Rs 1 lakh under the Income Tax Act. An investor can invest more than this, but that amount will not be eligible for a tax exemption.
As the fund manager of an ELSS knows that you will not withdraw your funds for three years, he can invest all the funds, say, in mid-cap companies, which can give higher returns, and not be worried about volatility in the short term.
An ELSS works much the same way as an equity mutual fund. The only difference being in open-ended equity mutual funds you can sell your units any time after purchase and there is no lock-in period. In ELSS, there is a lock-in period of three years, from the date of purchase. In case you apply jointly with your spouse, only the first holder is entitled to tax benefits. There is no compulsion to invest in ELSS every year. The investment can be based on your requirements.
According to the Association of Mutual Funds in India (AMFI), there are about 35 ELSS schemes. ELSS is almost a mirror image of pure equity funds with just the difference of the three-year lockin period. On the performance front, pure equity funds don't beat ELSS by a considerable margin. There is a small difference in terms of returns that ELSS offer in comparison to pure equity diversified funds.
Tax-saving instruments like PPF, NSC and various insurance policies have always been on the priority list of investors. ELSS which offer investors a tax shelter and also equity exposure, with no entry or exit load, must not be used only as a tax-saving option. These funds do as well on the returns front.
ELSS has a three-year lock-in period, and this hardly pressurises fund managers to make changes in the investment portfolio, and therefore enhances returns of the fund. Investors need to consider ELSS for its investment potential, rather than just when the tax season arrives. In a bear market phase, most fund managers are under redemption pressures in pure equity funds. ELSS, which have a three-year lock-in, are not susceptible to such pressures and fund managers can hold on to stocks with potential.
