Equity-linked savings scheme (ELSS) is a diversified equity mutual fund where majority of the money is invested in the equity market. As the return is derived from the equity performance over the years, the returns are higher as compared to returns derived from Public Provident Fund (PPF), National Saving Certificates (NSC) and fixed bank deposits. Moreover, investors have additional tax bonanza in the form of tax deductions till Rs 1.5 lakh in a financial year offered under section 80C of the Indian Tax Act, 1961, and long-term capital gains over Rs 1 lakh being taxed at the rate of 10%. The lock-in period of ELSS funds is 3 years and the investor can exit the scheme after selling it after this period. This lock-in applies to the units of mutual funds and not the investment amount. The investment becomes eligible for withdrawal when the units bought complete three years irrespective of the amount invested.
Investors have the flexibility of investing in two ways:
- Invest in lump sum in one go
Near the year-end, let’s say on December 31st, 2017, an investor decided to avail the tax deduction and exemption available in ELSS by investing Rs 100,000 by purchasing 1000 units of the mutual fund selling at a Net Asset Value (NAV) of Rs 100. The investor can liquidate it on December 31st, 2020 at the prevailing NAV. NAV is the value of one unit of a particular mutual fund which reflects its intrinsic value.
- Invest through Systematic Investment Plan (SIP)
The same Rs 100,000 can be invested in installments through a systematic plan. For an investor willing to invest the same amount in 5 monthly installments at different NAVs prevailing in the market, each unit occupied shall be eligible for withdrawal on the completion of three years from the purchase date.
The unique features of Equity Linked Saving Scheme making it an attractive investment option:
- The lock-in period of just 3 years makes it more investment desirable for investors looking for immediate liquidity. Other tax saving investment options like NSC, PPF and bank fixed deposits have a lock in of 5 years, 15 years and 5 years, respectively.
- It is an equity-oriented investment scheme. Hence, returns offered are higher than the returns derived from risk-less investment options. Also, the returns offered by ELSS are not guaranteed as it is an equity based mutual fund which is subject to market performances.
- The difference between an equity linked saving scheme and mutual fund is that there is no lock in mutual funds. Also, the Income Tax Act, 1961 does not offer any tax deduction for mutual funds.
- There is no maximum limit of investment.
- There is a lot of documentation required at first which may dissuade some investors.
The different investment options available under ELSS are:
- Growth Option: Under this, the investor does not receive any benefit via dividends. The wealth created in the form of increased Net Asset Value is offered to the investor upon maturity. It is impertinent to emphasize that the NAV is greater in growth option as compared to the dividend option.
- Dividend Option: The benefits are received periodically instead of a lump sum payment at the time of withdrawal. The dividends received are exempt from tax. It is ideal for holders looking for recurring cash inflows.
- Dividend Reinvestment options: Under this option, the dividend distributed is added back and reinvested at the prevailing NAV. It is a good option to consider when the market is performing well over the course of the investment period.
The decision to invest in these options depends on the investment amount and tax-return trade off. Dividend is tax-free, however, the long-term capital gain is taxable at 10% above Rs 1 lakh. The effective annual return of an investor can vary under these investment options. Hence it is advisable to consider all the factors before making an investment.