A complete guide to tax saving mutual fund investments

Tax planning is one of the important aspects of financial planning as a considerable portion of income goes in paying either direct or indirect taxes. Though you cannot reduce the indirect tax burden, you can reduce your direct tax burden with efficient tax planning and proper execution. The most important factor in choosing the right investment option which not only helps you minimize your tax burden but also help in wealth creation.

Tax saving mutual funds known as Equity Linked Savings Scheme or ELSS is one of the most efficient tax saving investment option under section 80 C of the Income Tax Act, 1961. Investments in ELSS provide you the opportunity for long-term capital appreciation and at the same time offer tax benefits.

What is an ELSS Fund?

ELSS or equity-linked savings scheme is a diversified mutual fund which invests a sizeable portion in the equities and equity-related schemes. Unlike traditional tax saving instruments which invest primarily in debt products, ELSS provides investors the opportunity to earn higher returns by undertaking the risk inherent in equity investments.

Key characteristics of ELSS mutual funds

• They are diversified equity funds which invest a majority of their assets in shares of companies with different market capitalization and across different sectors. In general 65 to 80% of the assets are invested in equities.
• Investments in ELSS enjoy EEE benefit which means that the amount invested in ELSS is exempt from tax, the dividend received in the hands of investors is also exempt from tax and no capital gains tax is levied at the time of redemption. Though there is no limit for exemption on the amount of dividend received and maturity amount the maximum exemption for investment is limited to Rs. 1, 50,000 only.
• The minimum investment amount in ELSS fund is Rs 500 and there is no cap on the maximum investment amount.
• The minimum lock-in period in such schemes is of 3 years. An investor is not allowed to redeem or transfer units during the lock-in period. Compared to other tax saving options, ELSS has the lowest lock-in period and hence considered the most liquid tax saving option.
• Since ELSS has a lock-in period of 3 years, there is no sudden outflow of funds in such schemes in case investors panic in volatile markets, thus increasing the chances of capital appreciation.
• Historically, ELSS funds have given higher returns as compared to other tax saving investment options.
• Since ELSS has exposure in equities, they carry higher risk as compared to other tax saving instruments.
• Investments in ELSS can be made lump sum or in the form of monthly SIP. Thus, ELSS offer you the flexibility to invest in one go or monthly installments.

Why ELSS score over other tax saving instruments?

• The lock-period in ELSS is lower: ELSS has the lowest lock-in period of 3 years as compared to other tax saving instruments such as PPF, EPF, NSC, Tax saving FDs, ULIPs etc. Thus, ELSS scores over other investment options in terms of liquidity.
• Opportunity for long-term wealth creation: While most of the tax saving instruments invest in debt products and offer a fixed return, ELSS gives investors a chance to in the equity market. Time and again, equity as an asset class has outperformed other asset classes in terms of returns in the long run. Thus, ELSS gives the investors opportunity for wealth creation in the longer term through professionally managed investments in equity markets.
• Cost of ELSS is lower: Though Unit Linked Insurance Plans (ULIPs) also over tax benefits and equity investments cost of ELSS investments is much lower than that of ULIPs. ULIPs are expensive as they invariably have mortality charges.

Thus, a mutual fund investment through ELSS is one of the best investment options if you are looking to save taxes along with long-term capital appreciation.