From the shortest lock-in to tax-free gains, an ELSS plugs a crucial hole in taxpayers’ strategy
As salaried employees start tax planning, equity-linked savings scheme (ELSS) of mutual funds can be a worthwhile option with markets on a roll. Under the Income Tax Act, 1961, up to R1.5 lakh invested in ELSS during a year is eligible for deduction under Section 80C.
An ELSS has a lock-in period of three years. This is the lowest among all tax-saving instruments, including Public Provident Fund (PPF), National Savings Certificate (NSC) and five-year bank fixed deposits.
An ELSS invests primarily in stocks of listed companies. For those in the highest tax bracket, investing up to R1.5 lakh in ELSS in a year can bring tax savings of as much as R46,350.
Analysts say one must have some equity exposure for high long-term returns — an ELSS is a good option as one does not have to monitor the performance of individual stocks. And, by selecting a good ELSS, an investor not only diversifies but also gets tax benefits and better post-tax returns.
Returns, however, depend on the fund manager’s ability to pick the right stocks. Therefore, an investor must select a fund after enough research. Instead of opting for a fund with high, but volatile, returns, he must select a fund with stable performance. Returns also fluctuate depending on the performance of the equity market.
Since an ELSS has over 65% of its corpus invested in stocks, it is exempt from tax on long-term capital gains, as is the case with any equity fund. The dividend income is also tax-free. ELSS is the only option among tax-saving instruments that gives tax-free dividends, apart from capital appreciation.
An ELSS also offers systematic investment plans (SIPs), which are ideal for the salaried. By taking the SIP route, one can stagger investments, which, in turn, brings down risk sizeably. In fact, rupee-cost averaging, which lies at the heart of SIPs, is an effective mechanism that eliminates the need to time the market.
An investor can put away as little as R500 in an ELSS, unlike other equity-oriented funds where the minimum investment is R5,000. However, the money invested on a monthly basis gets locked in for three years from the date of investment.
An ELSS provides growth, dividend payout and dividend reinvestment options to investors. Analysts say the growth option is ideal for the salaried because of compounding benefit. Under the growth option, the investor doesn’t get any income during the duration of the investment — he gets the proceeds only when the tenure ends. The proceeds are in the form of a lump sum.
Under the dividend option, the investor gets steady income throughout the duration of the investment. However, the income is unpredictable, depending on the markets.
Under the dividend reinvestment option, an investor gets locked in forever. For ELSS, fund houses announce a dividend and, in the dividend reinvestment option, the dividend gets reinvested and locked in for another three years. As a result, you will never be able to withdraw your investment, even if it is underperforming.
Before investing in an ELSS, one must analyse the track record of the fund for a long period, say, a year, instead of just looking at two-three months’ performance. He must also check the dividend payout and whether the fund is adequately diversified across sectors.
One must consider such funds where the assets under management (AUM) are more than R500 crore — such schemes happen to have gained investors’ confidence over a long period of time.
To invest in any mutual fund, one must have a PAN card and should have filled out the Know Your Client (KYC) documents. If the application form and the money is given to the fund house before 3 pm, units are allotted based on the NAV of that day and the account statement is sent to the investor within a week. This can be tracked online.
Analysts draw parallels between unit-linked insurance plans (Ulips) and ELSS — both offer tax benefits and the corpus is invested in equity markets. Also, unlike Ulips, an ELSS does not offer the switching facility, which means during volatile times one can’t migrate from equity to debt.