Is investing in ELSS a good idea?

Can an individual save or invest more than Rs 1.5 lakh in ELSS mutual funds in a financial year? What are the tax implications on ELSS?

- VK Chandrika, Bapatla

Equity Linked Savings Schemes (ELSS) are mutual fund investment schemes that help you save income tax. ELSS MF schemes are also known as tax-saving funds. Investments in ELSS allow individual assesses or HUF a deduction from the total income of up to Rs 1.5 lakh under Sec 80C of the Income Tax Act 1961. ELSS mutual fund schemes have a lock-in period of three years from the date of investment in MF units. After the lock-in period, the units can be redeemed or switched.

ELSS MF schemes offer both growth and dividend options. Investors who want to put their money in ELSS can also invest through Systematic Investment Plans (SIP). Investments up to Rs 1.5 lakhs made in an ELSS fund in a financial year are eligible for a tax deduction under 80C. From tax benefits to high returns, ELSS has many advantages, disadvantages, features and benefits, including the potential to deliver higher returns.

While ELSS has a lock-in period of three years, a tax-saving fixed deposit has a lock-in period of five years. A PPF (public provident fund) account has a 15-year lock-in period, and an NSC (national savings certificate) and NPS (national pension scheme) have lock-in periods of five years and until retirement, respectively. This short lock-in period feature makes ELSS a popular tax-saving option compared to Tax Saving FD, PPF, NSC, and NPS. While they may deliver lower returns than ELSS, they guarantee financial safety. When it comes to returns, ELSS has the potential to give between 12 per cent and 18 per cent returns. In comparison, PPF and NSC will deliver between 8 per cent and 9 per cent; NPS assures between 10 and 11 per cent return but under specific terms and conditions. Tax-saving fixed deposit interest rates usually range from 5.5 to 7.5 per cent. However, the interest earned from these types of FD schemes is taxable. Another advantage of ELSS is that, unlike a fixed deposit where one can put in a lump sum amount, one can invest in SIPs that can be as low as Rs 500 per month. ELSS allows investors to invest either in a lump sum or a SIP.

There is no upper or maximum limit to invest, although the maximum limit for exemption is Rs 1.5 lakh under the Income Tax Act. People can invest more than Rs 1.5 lakh in ELSS schemes if looking at the ELSS fund as a tax-saving option. ELSS fund schemes are diversified; hence your portfolios with ELSS have the potential to get higher returns. Also, a diversified portfolio mitigates the risk of a volatile stock. Moreover, if the stock market is doing well, you can get higher returns through an ELSS.

Returns are not guaranteed as ELSS MF schemes are subject to market risks. You cannot make a premature withdrawal during the three-year lock-in period, and you may pay penalties if you withdraw prematurely. Hence, ELSS MF schemes are a popular investment option. However, one must restrain from investing in the ELSS MF schemes if the investor is disinclined or reluctant to take risks. ELSS is not the safe route or mode of investment for risk-averse investors. Those with risk tolerance may consider ELSS MF schemes rather than investing in FD, PPF, and NSC.

Finally, regarding taxation, you can have a tax deduction of Rs. 1.5 lakh under Section 80C of the Income Tax Act. However, the returns you gain are partially taxable. The long-term capital gains from an ELSS are exempt from tax, but only up to Rs. 1 lakh.

Here are some of the critical features of an ELSS MF scheme: One can invest as little as Rs 500 in an ELSS MF scheme.

ELSS funds invest a large percentage of their portfolio in equity. ELSS Mutual Funds do not have any entry or exit load. ELSS MF schemes have a compulsory lock-in period of 3 years, which is the shortest among all tax-saving instruments. ELSS offers the dual benefits of capital appreciation from equity investments and tax savings. The best funds in the ELSS category may generate returns of 10 to 18 per cent in the long run, among the highest in the tax-saving category of instruments. However, ELSS MF also comes with some risks inherent in equity investments. One can opt for dividend payouts if one wishes to receive regular income or the growth option for capital appreciation.

Like all equity mutual funds, investments in ELSS MF schemes are subject to market or systematic risk. Investors must read all the scheme-related documents carefully. This write-up is meant only for general reading and awareness purposes and cannot be considered or viewed as a recommendation.

(The author is a SEBI licensed Research Analyst. The alumnus of the Indian Institute of Foreign Trade (IIFT), he had held leadership roles at National Geographic, Reliance Radio Television Luxembourg, STAR TV, etc)