All about ELSS (Equity Linked Savings Scheme)

Introduction

ELSS is a type of diversified equity mutual fund that invests a majority of its funds (about 80%) in equity and equity related schemes. ELSS investments have a lock-in period of 3 years. During the lock-in period, an investor cannot redeem or transfer the units to another scheme. However, investors can claim the tax benefits for the F.Y. in which they have invested in the ELSS u/s 80C of the Income Tax Act. The stocks are chosen from across market capitalization (Large Caps, Mid-Caps, Small-Caps) and industry sectors. These funds aim to maximize capital appreciation over the long run. The fund manager picks stocks after conducting an in-depth market research to deliver optimal risk-adjusted portfolio returns.

Lock-in

ELSS investments have a lock-in period of 3 years. In no case an investor can withdraw units, once invested.

How to invest

Any person intending to invest in ELSS can invest in either of the two ways-

• Monthly SIP
• Lumpsum

Minimum Investment

Any person intending to invest in ELSS can invest as low as Rs. 500 by way of monthly SIP or Lumpsum payment. However, there's no upper limit on investment.

Ways to invest

• Growth option: When you go for the growth option, you will not receive benefits in the form of dividends. As an investor, you will get the gains only at the time of redemption - this helps to appreciate the total NAV and thus, the profits multiply. There's one thing to keep in mind - the returns are subject to market risk.
• Dividend option: Under this option, an investor gets benefits from time to time in the form of dividends, which are completely tax-free. The dividend is declared only when there are excessive profits, over and above.
• Dividend Reinvestments option: This is an option under which an investor reinvests the dividends received to add to the NAV. This works well, particularly when the market is witnessing an upswing and is likely to continue the same way.

Factors to be considered while choosing a fund

• Expected return/ gain
• History of NAV/ NAV trend
• AUM (fund size)
• Expense ratio
• Exit load
• Financial parameters
• Fund manager
• Beta (β)
• Age of fund
• Risk involved

Deduction u/s 80C

ELSS is one of the investment options available under Section 80C of the Income Tax Act, 1961, which allows a tax benefit up to Rs. 1.50 lakhs in a F.Y. to the taxpayer. The amount of tax benefit is equal to the amount invested during the period, subject to the overall ceiling limit of Rs. 1.50 lakhs considered for all eligible payments/ investments taken together.

Taxation

As there is a lock-in period of 3 years, the investment will be considered as a long-term investment from Income Tax point of view and the gain arising as on the date of withdrawal shall be long term capital gain. Accordingly, the applicable tax rate is 10% (plus applicable cess and surcharge) which will be applicable only if the return/ gain exceeds Rs. 1,00,000.

Types

• Open-End ELSS: Under this scheme, the investors can invest in an ELSS at any given time as per their preference. The 3-year lock-in period is however applicable, but once the lock-in period ends, redemptions can be made at any time of the investor's choice.
• Closed-End ELSS: Close-ended ELSS only takes investment during the NFO (New Funds Offer) period and after that, they are closed for investments. Additionally, the investors can liquidate their investment in the closed-end fund after completion of the 3-year lock-in at only specific periods of time as declared by the fund from time to time.

Advantages of investing in ELSS Mutual Funds

• Shortest lock-in period: ELSS has the shortest lock-in period of 3 years as compared to Tax-saving FD having 5 years lock-in & PPF having 15 years of lock-in.
• Higher returns: Unlike ELSS where return is market linked, other 80C investments like PPF or FDs are fixed income products. ELSS has the potential to generate significantly higher wealth in a medium to long-term investment horizon.
• Tax-free Dividends and Capital Gains: The return on amount invested in ELSS is not taxable up to Rs. 1 lakh.
• Monthly SIP: An investor can either invest a lump sum amount in an ELSS Scheme or opt for monthly SIP, according to his risk appetite and cash position. Minimum investment being Rs. 500.
• Tax Deduction u/s 80C: Investments made in ELSS can be claimed as deduction u/s 80C of the IT Act subject to maximum overall limit of Rs. 1,50,000 in the year of investment.

Redemption

Unlike most of the eligible investments under Section 80C, the investments in ELSS units are not redeemed at the end of the lock-in period. As such, one can continue to stay invested in such funds, even beyond the 3-year lock-in period. This allows the investors to link such investments with their long-term financial goals. As such, ELSS enables investors to club their tax savings and financial plans together.

Top performing ELSS funds

• Quant Tax Plan
• IDFC Tax Advantage (ELSS) Fund
• Mirae Asset Tax Saver Fund
• Canara Robeco Equity Tax Saver Fund
• DSP Tax Saver Fund

Conclusion

Unlike a diversified equity fund, an ELSS has a mandatory lock-in period of 3 years. It does not matter whether you are getting Section 80C benefits or not. The lock-in period of 3 years will still be applicable. You should never make an ELSS allocation decision in isolation. It should be part of your overall financial plan. Remember that ELSS will qualify as equity exposure in your overall financial plan. You need to take this decision based on the total exposure to equities that your plan allows. If the ELSS is going to overexpose you to equities, you need to be careful because you are locked in for a period of 3 years at the very least.

Finally, ask yourself a pertinent question - What is the return advantage that ELSS provides over diversified equity funds?

As an individual, I would consider the following points:

• Whether I have other deductions available u/s 80C?
• What is my income level?
• What is my expenditure pattern?
• What are my future plans (specifically in the coming 3 years post investment)?
• What is my risk appetite?

Hence, the amount of investment, time of investment and the choice of fund to invest in, is a subjective matter and depends upon a number of factors.

Disclaimer: The author is based in Jabalpur and is a Practicing Company Secretary dealing in Corporate, Legal & Taxation services. The information contained in this write up, as provided by the author, is to provide a general guidance to the intended user. The information should not be used as a substitute for specific consultations. Author recommends that professional advice is sought before taking any action on specific issues.

The author can also be reached at cstanveersaluja@gmail.com