How to plan your taxes through Equity Linked Savings Schemes (ELSS)…

Equity Linked Savings Scheme (ELSS) is a tax saving scheme that has been around for quite many years. It is like any normal equity investment scheme, but it has a lock-in period of 3 years. The designated units once bought will have to be necessarily held on and cannot be redeemed till the completion of 3 years from the date of purchase. Apart from being an efficient tax saving mechanism, it also a good source of stable long term returns and substantially enhances your effective yield due to the tax advantages.

How can one invest in an ELSS…?

Remember, an ELSS is like any other normal equity mutual fund scheme. Most of the fund houses have an ELSS scheme of their own. There is no additional KYC that needs to be done for ELSS. Your existing mutual fund KYC is sufficient for you to invest in an ELSS scheme. Like in case of a normal mutual fund investment, you invest and get the units credited to your account. The only difference is that the units cannot be redeemed for a period of 3 years from the data of purchase. One can also do a SIP in an ELSS. When you need to plan your taxes for the whole year, an SIP on an ELSS makes a lot more sense. The only difference here is that each SIP instalment will have a lock-in of 3 years from the date of the purchase and cannot be redeemed during the period. Of course, there is an option to redeem your ELSS under exceptional circumstances, but in that case you forfeit the tax benefit availed by you.

What are the advantages of investing in an ELSS?

The first advantage is that you get a tax break under Section 80CCD (1) up to a limit of Rs.150,000/- on your ELSS investment. Of course, this will be clubbed with other investments like LIC premium, PF contribution, principal repayment of a home loan, long term FDs and the overall investments will be subject to a limit of Rs.150,000/. So when you invest Rs.150,000/-, you straight away get a benefit of Rs.50,000/- at your peak tax rate. Of course, we are assuming that you do not have any other qualifying Section 80CCD(1) investments. That means you are actually investing only Rs.100,000/-. This becomes important when you calculate your final yield at the end of 3 years. Let us assume your investment of Rs.150,000/- appreciated to Rs.240,000 at the end of 3 years. Now you have earned a profit of Rs.90,000/- on an investment of Rs.150,000/- i.e. 60% in 3 years. But hold your breath, you only invested Rs.100,000/- net of tax breaks. So effectively your return is 90% and not 60%. That really explains the importance of the tax break in ELSS.

Do ELSS schemes perform better than other equity schemes?

It has been seen that ELSS, despite being an equity scheme, tends to outperform other equity schemes in most cases. There are 3 reasons for this phenomenon. Firstly, since ELSS has a 3-year lock-in period, fund managers do not have to overtly worry about maintaining liquidity to meet redemption pressures. Hence fund managers at most times are able to make unbiased long-term investment decisions. This works to the advantage of the ELSS investor. Secondly, because of the 3-year lock-in, an ELSS operates almost like a closed-ended fund. This enables them to bet more realistically on the long term trends and themes in the market. Lastly, inflows in these ELSS schemes tend to be bunched around the tax saving period from January to March. This leaves a larger lock-in corpus to be deployed around the beginning of the new financial year and make the best of the post-budget opportunities in the market. As a result, ELSS schemes tend to give a higher return on investment even without counting the tax benefits of the scheme.

Why it makes sense to investors…

Most investors must ensure that they do allocate some of their Section 80CCD (1) corpus to ELSS. It has two advantages. It results in forced savings in equities that create long term wealth for the investors. Secondly, the 3-year lock in period helps them to better understand the benefits of long term investing rather than trading in an out of mutual funds. When you consider the effective returns after the tax effect, the actual effective yield can be a huge number. That is surely like hitting two birds with one stone. On the one hand you get smart returns and on the other hand you also save on taxes.

In conclusion, most investors must explore ELSS as a very important means of tax planning. It not only saves tax but also inculcates the investment discipline in you. To the extent possible try to do an ELSS though SIPs, so that you derive the triple benefit of long term investing, tax benefits and the added advantage of rupee cost averaging.

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One response

  1. Equity Linked Savings Scheme(ELSS)is a taxing saving scheme which is similar to other equity schemes but comes with a lock-in period of 3 years. Most mutual fund companies have their own ELSS schemes. You don’t need an extra KYC to invest in ELSS. Your present mutual fund KYC is enough in order to make such an investment.

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