Equity Linked Savings Scheme, commonly referred to as ELSS, is an open ended tax saving scheme that comes with a three year lock in and tax benefit. ELSS is the only mutual fund scheme that comes under Section 80C of the Indian Income Tax Act, 1961 and is eligible for tax benefit. These days, more and more individuals are switching from conservative tax saving schemes to ELSS for a variety of reasons. The problem with most conservative tax saving schemes is that they come with lengthy lock-in periods. Also, there is zero flexibility when it comes to investing in conservative tax saving instruments. In case of a financial exigency, you won’t be able to liquidate your investments and your money is frozen since the lengthy lock in periods can range anywhere between 5 to 15 years (more in case of some schemes). ELSS, on the other hand, comes with a predetermined lock-in period of 36 months. Having said that, this three year lock-in period is probably the lowest among other tax saving schemes that come under Section 80C.
Here’s a less complex example to help you understand how ELSS works –
Rizwan Ahmed is a senior operations manager with a social media marketing agency who draws and annual salary of Rs. 12 lakhs. This lands him in the highest tax bracket. Rizwan learns about ELSS from a friend and decides to invest Rs. 1.5 lakh in the tax saver fund. Now according to 80C of the Indian Income Tax Act, 1961 an individual can invest up to Rs. 1,50,000 in ELSS and claim tax deductions for the same. By investing in ELSS Rizwan’s gross taxable income has now come down to Rs. 10.5(12-1.5) lakhs per annum. Also, the three year lock in gives the amount invested an opportunity to earn interest and might even help Rizwan building wealth over the long term.
How important is the lock-in period in ELSS?
Although ELSS comes with a predetermined lock-in period of 36 months, investors need not withdraw the capital gains earned at the end of their three year investment journey. If the ELSS fund that you invested in is performing as per your expectations and you believe that it can offer you better capital appreciation in the long run, you can remain invested in the scheme till your investment objective is achieved. The lock-in period does help as this an equity oriented scheme. Those who are frequent mutual fund investors, they must be aware that one needs to remain patient and invest keeping a long term investment horizon if they want to witness the true potential of any equity mutual funds scheme. Thus, you can invest in an ELSS scheme not just to save tax but to also target your life’s long term financial goals like retirement planning, buying a weekend home, planning a destination wedding for your daughter or planning for your children’s future.
If you want to achieve capital appreciation over the long term, you can consider starting a SIP in ELSS fund. A Systematic Investment Plan is an investment method where you can invest small amounts at fixed intervals. Investors need to allow auto-debit from their bank so that every month on a fixed date, a predetermined amount is debited from the investor’s savings account and electronically transferred to the ELSS scheme. One can even refer to SIP calculator, a free online tool available online that helps investors get a rough estimate on the capital gains they might earn at the end of their investing journey.
It is better to determine your risk appetite before investing in a scheme like ELSS that has an equity heavy portfolio.