ELSS Funds - Meaning and Tax Saving Fund Investment Scheme

Do you want to save taxes while also growing your wealth? If yes, then ELSS funds could be your perfect investment option. Many taxpayers look for ways to reduce their taxable income. What is ELSS, if not the best combination of tax saving and long-term wealth creation?

ELSS, or Equity Linked Savings Scheme, is an open ended tax saving fund that invest specifically in equities. So why is it different? The lock-in period of an ELSS is three years, which is shorter than that of a PPF or NSC. ELSS investment has the ability to give better returns compared to most tax-saving funds as well. Now, let's understand why these tax saving investments on ELSS funds are so important for your portfolio.

What is ELSS? (ELSS Full Form & Meaning)

The definition of ELSS is Equity Linked Saving Scheme. It is a type of pension fund, a subtype of a tax saving fund that invests predominantly in shares (stocks). Moreover, ELSS funds offer the highest tax reduction over PPF and NSC since you can claim it under 80C and receive a deduction of up to ₹ 1.5 lakh annually. You may be wondering how ELSS funds are different than other tax saving schemes:

• Overall lock-in period is very short, only 3 years compared to more than 5 years with PPF or NSC.
• The average return is typically 10-12% annually, considerably higher than the average fixed income options.
• It can be invested in as a lump sum or through SIP (Systematic Investment Plan).

Key Features of ELSS Funds

If you are looking into how to invest in ELSS, the first step is to understand what makes these types of funds stand out. The following includes some vital characteristics of the ELSS funds:

Why Should You Invest in ELSS Funds?

If you are looking for an investment option that helps save on taxes while simultaneously generating high returns, consider ELSS funds. These funds offer the most favourable combination regarding saving taxes, getting exposure to the equity markets, and building wealth over time. We will examine why using ELSS tax saving funds is a good decision.

1. Dual Benefit – Tax Saving & Wealth Growth

   One of the biggest advantages of investing in ELSS funds is tax savings and wealth accumulation.
   • Tax Savings: ELSS funds are tax saving investments that allow you to deduct some of your taxable income under Section 80C of the Income Tax Act. You can get tax deductions of up to ₹1.5 lakh a year, reducing your taxable income. If you are in the highest tax bracket (30%), you may save a tax of up to ₹46,800.
   • Wealth Growth: Since ELSS funds primarily invest in equities, they tend to outperform traditional tax saving investments such as PPF and FDs. The earlier you start investing, the greater the long term compounding effect.
   In this way, ELSS investment allows you to build wealth while availing tax benefits, a unique proposition among tax saving investments.

2. Shortest Lock-in Period – Just 3 Years!

   The lock-in period is one of the biggest concerns when considering tax-saving investments. Most traditional tax saving instruments have an extensive lock-in period which hinders liquidity.
   Here’s a comparison between other tax saving funds with ELSS funds in terms of lock-in period:

   Investment Option	Lock-in Period
   ELSS Funds	3 years
   Public Provident Fund (PPF)	15 years
   National Savings Certificate (NSC)	5 years
   Fixed Deposit (Tax-Saving)	5 years
   Employee Provident Fund (EPF)	Till retirement

   With ELSS investments, the lock-in period is only three years, meaning the funds may be withdrawn or left to grow further after three years. This provides a lot of flexibility for investors who wish to gain tax benefits without having their funds locked for extended periods.

3. Flexibility in Investment – Lump Sum or SIP

   Just as some tax savings come with having a fixed investment amount, the ELSS tax saving funds come with a flexible investment option. This form of investment can be done in two different ways:

   A. Lump Sum Investment

   • This is suitable for investors with an extra cash flow who prefer to invest at once.
   • This approach can work miracles where the market is at a low down and is anticipated to grow.
   • Great care is needed as this approach relies heavily on market timing for better returns.

   B. SIP- Systematic Investment Plan

   • Everyone in formal employment aiming at investing smaller amounts periodically will find this approach perfect.
   • This helps reduce cost averaging to ensure each unit price makes the whole investment lower than when the market is high.
   • This method helps instil discipline in investing and makes it more convenient.
   If you are a novice in investment and are confused about how to invest in SIP, this method will allow you to invest stepwise, building your investment with time. SIPs also help reduce risks from market fluctuations hence making ELSS less risky and more of an investment structure.

4. Higher Returns Compared to Traditional Tax-Saving Options

   Returns are particularly vital when investing. Let us evaluate how ELSS performs about other tax-saving options:

   Investment Option	Expected Returns (Per Year)
   ELSS Funds	10-12% (Market-Linked)
   PPF	7-8%
   NSC	6-8%
   Fixed Deposits (Tax-Saving)	6-7%
   EPF	8.15% (for FY 2023-24)

5. No Entry or Exit Load – A Cost-Effective Investment

   Several mutual funds impose entry load (charge upon investment) and exit load (charge upon cashing out) fees. These fees often decrease any profits you would make from investing. With no such entry and exit fees, ELSS investment becomes an economical tax-saving alternative.
   
   Here’s the comparison:

   Investment Type	Entry Load	Exit Load
   ELSS Funds	No	No
   Regular Funds	Yes (in some cases)	Yes (if withdrawn early)
   Fixed Deposits	No	No
   ULIPs (Unit Linked Insurance Plans)	Yes	Yes

6. No Upper Limit on Investment

   There is a limit available for tax benefit under Section 80C of ₹ 1.5 Lakh, but there is no limit on how much an investor can put into ELSS. Investors are free to invest an unlimited amount and benefit from the long-term wealth creation by the equity markets.
   
   These features enable ELSS investments to stand out among other investment funds, especially for those intending to save excessive money for these investment purposes.

7. Long-Term Wealth Creation & Compounding Benefits

   Because an ELSS fund primary investments are acquiring shares of stock of publicly traded companies, they have long-term opportunities for wealth creation. Over time, the compounding effect of your investment will grow significantly.
   
   Suppose you allocate ₹5,000 monthly to an ELSS tax saving fund for 10 years with an anticipated yearly return of 12%. Here is how your wealth grows:

   Year	Total Investment (₹)	Wealth Gained (₹)	Total Value (₹)
   1	60,000	3,600	63,600
   5	3,00,000	1,12,716	4,12,716
   10	6,00,000	5,32,749	11,32,749

   After 10 years, your ₹6 lakh investment would grow to approximately ₹11.3 lakh as your money would nearly double! This is why sustaining investments in ELSS for long durations can be beneficial.

Who Should Invest in ELSS Funds?

ELSS funds are perfect for:

• Accounting professionals who want to take advantage of tax rebates
• Investors who are looking to invest in the stock market for the very first time
• Investors who have set long-term objectives
• Individuals who wish to get a better return than fixed deposits like FDs or NSCs.

However, unsuitable options include having an urgent need for liquidity in under 3 years or wanting to make risk-free investments.

Things to Consider Before Investing in ELSS Funds

ELSS (Equity Linked Savings Scheme) funds greatly save taxes while earning high returns. Here are a few things to keep in mind before investing in ELSS.

1. Risk Involved – Market Fluctuations Can Affect Returns

   ELSS tax-saving funds are equity-based investments that depend on the stock market economic cycles. This implies:
   • When the economy is good, an investor ELSS could earn high returns (historically 10-12% per annum).
   • When the stock market is down, the value of the investment may be reduced temporarily.
   Unlike fixed return instruments such as PPF or FDs, there are market risks associated with ELSS investment. However, this risk can be mitigated if you:
   • Stay invested for a longer duration (5+ years) to benefit from market volatility.
   • Invest through SIPs to take advantage of rupee-cost averaging.
   • Diversify the portfolio to reduce investment risk.

2. Returns Are Not Guaranteed – No Fixed Interest Like FDs or PPF

   ELSS tax saving mutual funds investment differs from traditional investments such PPF, FD, or NSC because they lack assurance of returns.

   Investment Type	Returns
   ELSS Funds	Market-Linked (10-12% historically)
   Fixed Deposit (FD)	Fixed (6-7%)
   Public Provident Fund (PPF)	Fixed (7-8%)
   National Savings Certificate (NSC)	Fixed (6-8%)

   As an equity fund, ELSS returns depend on the stock market performance. The market is bullish and your returns could be maximized; while a downturn exists, temporary losses may be observed.

3. Lock-in Period Rules – SIP Investments Have Different Lock-ins

   ELSS tax saving funds feature a mandatory lock-in period of 3 years which is the shortest compared to other Section 80C investments. But, if you invest through SIP (Systematic Investment Plan), it is important for you to know how the lock-in works.

   How Does the Lock-in Work for SIP Investors?

   If you make a lump sum investment today, you are locked in for 3 years.
   
   But if you are using SIP to invest:
   • Each SIP instalment is separately locked for 3 years.
   Example:
   • If you began an ELSS SIP in January 2024, your first SIP instalment would remain locked till January 2027.
   • Your SIP instalment in February 2024 will remain locked until February 2027.
   So, while ELSS is liquid after three years, if you’re using how to invest in SIP, you won’t be able to withdraw all your money at once.
   
   Solution?
   • A lump sum investment is the most suitable option if you prefer having full liquidity after three years.
   • If you prefer to invest regularly, then the rolling lock-in periods in SIPs should be understood.

4. LTCG Taxation – ELSS Returns Are Taxed Beyond ₹1 Lakh

   People tend to assume ELSS investments are tax deductible, but that is not the case. Although tax reductions are available under Section 80C, profits from ELSS funds are taxed under Long-Term Capital Gains (LTCG) tax.

   How Is ELSS Taxed?

   • Tax-free gains: Up to ₹1 Lakh for every financial year.
   • Taxable gains: A profit exceeding ₹1 Lakh will be taxed under 10% LTCG tax.
   Example:
   • If your ELSS Investments appreciate to ₹80,000, there will be no tax liability.
   • However, if your investment grows to 1.5 Lakh, the excess 50k will be taxed at 10%, incurring a liability of 5k.

Taxation of ELSS Funds

The taxation regulations on ELSS fund accounts for tax saving remain straightforward:

Hence, even if you are in the 30% tax bracket, you would only have to pay 10% tax on anything above 1 lakh.

Best Time to Invest in ELSS Funds

Several investors postpone investments in ELSS funds until March to save on tax. However, this might not be the smartest move. Instead, try following these tips:

• Start Early - Invest in ELSS tax saving funds at the start of the financial year to yield growth.
• Go for SIP – Investing through SIP lessens the risks while protecting one from market volatility.
• Stay Invested – The lock-in is 3 years; however, staying invested for 5-7 years gives better compounding benefits.

Conclusion

We hope now you know what is SIP and ElSS funds. Investing in ELSS funds is smart if you want to save taxes and build long-term wealth. These funds are a superb selection for all investors because, besides having the shortest lock-in period, they have the most flexible investment options like SIP and the possibility of high returns.

Are you interested in calculating your tax savings? Check out the PNB MetLife Income Tax Calculator to learn how much you can save using ELSS tax saving funds. Begin investing now for a better financial future!

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