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ELSS – Tax Planning with Mutual Fund

ELSS (Equity Linked Savings Scheme) is a (diversified) equity mutual fund scheme. It is one such investment option that provides tax saving benefits along with higher growth potential over time compared to other tax saving options.

With so many tax saving options available, choosing the right one depends on the investor’s financial goal and his/her risk appetite. However, we should always keep in mind that whatever option we chose, it should be able to beat inflation and create wealth and not just save tax. ELSS can be an ideal option here for many. Below mentioned points will let one understand features of ELSS and its comparison with other tax saving options.

1. Investments in ELSS get tax deduction benefit of up to ₹ 1,50,000 under Sec 80C of the Income Tax Act 1961.

2. ELSS being an Equity Oriented investment product is susceptible to market volatility and carry similar risk-return profile as equity funds. But for the same reason it has the potential to provide inflation beating capital growth over long term and outperform other tax saving options in terms of wealth creation.

3. ELSS comes with a lock-in-period of 3 years. But if you compare it with other tax savings options it has the lowest lock-in-period (PPF – 15 yrs., NSC – 5/10 yrs., ULIP- 5 yrs., Bank Deposits – 5 yrs., Post Office Time Deposits – 5 yrs.)

4. As there is a lock-in period of 3 years, the fund manager has the opportunity to stay invested for a long term without worrying about redemption pressure, thereby providing stability to the growth opportunities.

5. While investing in ELSS, investors can opt for growth or dividend option. With the growth option the investment grows with cumulative effect till the investment is redeemed and with the dividend option one can have cash flow (as an when dividend is declared by the fund) even during the lock-in-period.

Comparison of tax saving options

OptionsLock-in PeriodRate of InterestTaxation of returns
PPF15 yrs7.10%Tax Free
NSC5 yrs6.80%Taxable as per slab
Tax Saving FDs5 yrs5.40%Taxable as per slab
Post Office Time Deposits5 yrs6.70%Taxable as per slab
Equity Linked Saving Scheme (ELSS)3 yrshigher return potential as it is linked to market*Capital gains are taxable at 10%^

* 5 year avg. CAGR return of all ELSS schemes as on 31st December 2020 is 11.20%

^ Finance bill, 2018 proposes levy of income tax @ 10% (w/o indexation benefit) on long term capital gains exceeding ₹ 1 lakh from equity shares and equity Mutual Funds provided transfer of such units is subject to STT.

From FY 2020-21, dividend in the hands of unit holder is taxable as per applicable income slab rate. Such dividend received will attract TDS @ 10%. For individual, TDS will be applicable on entire dividend if it exceeds ₹5000/- in a FY. For FY 2020-21, the TDS is reduced to 7.5%.

ELSS is a good option (by most measures a better option) to save tax and create wealth over a long period of time.

Note: Consider tax saving as a goal and plan it early during a financial year rather than end up making unsuitable decisions in a haste by waiting until the last moment

SIP - a smart way of investing into ELSS

SIP can be considered a better way of investing into an ELSS fund. With SIP a fixed amount is invested each month. By doing so one ends up buying more units when the market is down and fewer units when the market is up. Thus, over time, this results in averaging out the cost per unit. With SIP one can start as low as ₹ 500 per month.

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