How ELSS funds can help you save taxes & grow your wealth

The beginning of a new calendar year is typically when salaried employees receive a request from their employers for submitting their tax-saving investment proofs. This adds momentum to tax-saving investments during the January to March period of each year which also marks the end of the financial year. People opting for the old tax regime actively seek tax-saving investment avenues to reduce their tax liabilities. From traditional fixed deposits and public provident funds to market-linked products like Equity Linked Savings Scheme (ELSS) and National Pension System (NPS), investors have a wide range of tax-saving options to choose from.

Although many people make tax-saving investments between January and March, but that is not ideal. It’s better to start investing at the beginning of the fiscal year. This allows for better planning, adequate savings, and prevents hasty investments in unsuitable instruments just for tax benefits.

In this story, we take a deep dive into Equity Linked Savings Scheme or ELSS funds and how investors could invest in them to not only save taxes but also potentially build a corpus for their future goals.

Also Read: Retirement Planning for Women: How to take control of your financial future

Let us begin by understanding the two available personal tax regimes in India. There are two tax regimes – the old tax regime and the new tax regime, and investors can select their preferred tax regime while filing taxes. The old tax regime is charactered by relatively higher tax rates but taxpayers can save taxes by investing in approved investments and reduce their tax liability. The new tax regime was introduced in the year 2020 and is characterised by relatively lower tax rates for each income slab but without any deductions on taxable income.

Taxpayers can compare their tax liabilities under both regimes and choose the regime most suitable to them. Till the end of July 2024, about 72% of taxpayers had opted for the new tax regime while 28% continued to be in the old tax regime. The new tax regime is also the default tax regime. Hence, if a taxpayer does not choose the preferred tax regime, the new tax regime is applicable by default.

“Each avenue of tax saving under the old regime has its own characteristics and taxpayers can select the avenues which aligns with their risk appetite and investment horizon. These investment options are available under Section 80C of the Income Tax Act, 1961 up to a cumulative limit of Rs 1.5 lakh per annum under the old tax regime. Additionally, contributions made to the NPS qualify for deductions up to Rs 50,000 per annum under section 80CCD(1B) of the Income Tax Act, 1961. Thus, taxpayers opting for the old tax regime can claim deductions up to Rs 2 lakh per annum cumulatively by investing in tax-saving avenues,” informs Satish Prabhu, Vice President, Head of Content & Products, Franklin Templeton India.

Traditional tax-saving avenues include options like tax-saving bank term deposits and National Savings Certificates. These avenues provide assured returns with a lock in period of 5 years. However, the interest earned from these sources are taxable in the hands of investors every year at their individual tax slab rates. Another traditional tax saving option is the Public Provident Fund (PPF). The returns from the PPF account are in the form of interest payouts which are tax free for investors. However, the lock in period in case of PPF is 15 years, which is the longest among all tax-saving options.

Potential to Save Tax and Build Wealth Over Long Term With ELSS Funds

Equity Linked Savings Scheme or ELSS funds are mutual funds which invest in equity markets and also provide tax benefits under section 80C of the Income Tax Act, 1961. “ELSS funds have a flexible investment mandate and can invest in companies across the market capitalization spectrum. They provide benefit in the form of capital gains to investors and these are subject to Long Term Capital Gains Tax (LTCG) after the lock-in period of 3 years (lowest among all tax saving avenues). The LTCG rate applicable on returns from ELSS funds are 12.5% over and above the exemption limit of Rs 1.25 lakh capital gains,” says Prabhu.

Investors can invest up to Rs 1.5 lakh per annum in ELSS funds to claim tax benefits under section 80C. While most investors rush to make tax-saving investments during the January to March quarter of each year, it would be prudent to adopt a staggered investment approach in ELSS funds through Systematic Investment Plans (SIP). A monthly SIP of Rs 12,500 in a ELSS fund could help one invest the required amount of Rs 1.5 lakh per annum for tax saving purposes. So, how could an SIP in ELSS funds benefit investors in the long term? Let us look at the below illustration.

“Assuming an investor begins a monthly SIP of Rs 12,500 in a ELSS fund at the age of 25 and continued to invest over 35 years till the age of 60 years. Over 35 years, the total principal amount invested would be Rs 52 lakh. Assuming a 12% annualised return, the value of the accumulated corpus would be Rs 6.9 crore after 35 years. However, an investor who delays investing by 5 years, and begins an SIP at age 30 and invests Rs 12,500 over 30 years, would accumulate a corpus of Rs 3.9 crore at age 60, assuming 12% annualised returns over the investment period,” says Prabhu.

Hence, delay in commencing one’s investment journey can significantly impact the value of the final corpus accumulated at the age of retirement.

For illustration purposes only. Past performance may or may not be sustained in the future and is not a guarantee of any future returns.

ELSS funds could be a good tax-saving avenue for investors opting for the old tax regime and seeking to create wealth over the long term. It provides the potential of saving up to Rs 46,800 per year in taxes for investors in the highest tax bracket and also helps investors adopt a disciplined approach to investing in equity markets for meeting their long-term financial goals.