ELSS Funds Meaning, Benefits, Eligibility, Features And How to apply

ELSS Funds

ELSS Funds, or Equity Linked Savings Scheme funds, are tax-saving mutual funds in India that seamlessly integrate the advantages of equity investments with tax deductions under Section 80C. With a mandated 3-year lock-in period, ELSS presents an opportunity for substantial returns and tax savings, making it an attractive option for investors with a long-term outlook.

What is an ELSS Fund?

ELSS funds are a type of equity funds that mostly invest in stocks or related instruments. They are often known as tax-saving schemes because they provide tax benefits, allowing you to exempt up to Rs. 150,000 from your yearly taxable income under Section 80C of the Income Tax Act.

True to their name, ELSS funds are equity-focused plans with a mandatory three-year lock-in period. In recent times, many taxpayers have chosen ELSS schemes to enjoy tax advantages. By investing in ELSS schemes, you can receive tax exemption on the invested amount, up to a maximum of Rs. 150,000. Additionally, any earnings from this scheme after the three-year period are considered Long-Term Capital Gain (LTCG) and are subject to a 10% tax if the income exceeds Rs. 1 lakh.

Key Features of ELSS Mutual Funds

Lock-in Period: It comes with a minimum lock-in period of 3 years.
Equity Exposure: ELSS invests a minimum of 80% of the corpus in equities.
Tax Saving: Investments made in ELSS qualify for a tax deduction under Section 80C, up to Rs 1.5 lakh.
Market-Linked Returns: ELSS provides returns linked to market performance, dependent on the underlying equities in the portfolio.
Diversified Portfolio: ELSS funds typically diversify their investments across various sectors, reducing concentration risks.

Investing in ELSS not only aligns with wealth creation through market-linked returns but also ensures tax benefits, fostering a well-rounded investment approach.

How ELSS Mutual Funds Works

ELSS funds function as diversified equity funds, predominantly investing in stocks of listed companies. This investment approach spans market capitalisation categories, including large, mid, and small caps, as well as various sectors. The primary objective of ELSS funds is to achieve maximum capital appreciation over the long term. Fund managers meticulously select stocks through in-depth market research to yield optimal risk-adjusted portfolio returns.

Investments in ELSS funds qualify for tax benefits under Section 80C of the Income Tax Act, 1961. While there is no upper limit on the investment amount, a maximum of Rs. 1.5 lakh is eligible for tax deduction under the IT Act. Investing this amount in ELSS can result in annual tax savings of up to ₹46,800.

ELSS Mutual Funds Tax Benefits

According to Income Tax rules, investments in ELSS are eligible for a deduction under Section 80C, allowing a deduction of up to Rs 1.5 lakh. This can lead to tax savings of up to Rs 46,800.
Due to the 3-year lock-in period, premature redemption of ELSS funds is not permitted. If redeemed before three years, long-term capital gains tax at 10% is applicable. However, gains within the limit of Rs 1 lakh are exempt from tax.

ELSS Funds: Who All Should Invest

Salaried Individuals: For salaried employees contributing to the Employees' Provident Fund (EPF), which is a fixed-income product, ELSS provides an opportunity for higher returns on their investment portfolios. Beyond delivering good returns over the long term, ELSS investments also qualify for tax deductions under Section 80C. While unit-linked insurance plans (ULIPs) and the National Pension System (NPS) offer similar benefits, they come with longer lock-in periods and potentially lower returns. ULIPs, for instance, have a lock-in period of five years, and NPS, designed more for retirement, involves partial exposure to equity with funds locked until the age of 60. ELSS funds, in contrast, have a shorter lock-in period of just three years.

First-time Investors: New investors find ELSS an excellent choice due to its tax benefits and an introduction to equity investing through mutual funds. While equity investments inherently carry higher short-term risks due to market volatility, these risks decrease significantly when investing for more than five years. Starting with monthly Systematic Investment Plans (SIPs) in an ELSS fund enables investors to accumulate more units during market downturns and potentially generate favorable returns during market upswings. This gradual investment approach aids in navigating the volatility associated with equity investments.

Factors to Consider Before Investing in ELSS

When deciding to invest in an ELSS mutual fund, consider the following factors:

Investment Horizon: Plan for an investment horizon exceeding five years, as ELSS funds, with their equity exposure, require a longer commitment to counter market volatility effectively.
Returns: Recognize that ELSS funds don't guarantee returns; they depend on underlying securities' performance. However, a horizon of over 5 years may yield higher returns compared to other tax-saving options.
Lock-in Period: ELSS mutual funds have a mandatory three-year lock-in period. Your investments are tied up for three years from the date of investment, and you cannot redeem them before this period concludes.

ELSS Fund Mode – SIP or Lumpsum

Systematic Investment Plan (SIP): Recommended for those averse to higher risks. SIP allows you to invest across business cycles, benefiting from purchasing fund units at varying market conditions. This strategy averages out the purchase price over time, potentially leading to lower costs and higher gains upon redemption.
Lump Sum: Not advisable unless the market is in a bearish trend, and you are comfortable with higher risk and a more extended investment horizon. Investing a lump sum means missing the opportunity to buy fund units across business cycles, requiring a commitment of longer than 5-7 years for optimal gains.

Key Considerations Before Investing in ELSS Funds

Fund Returns: Evaluate the fund's performance by comparing it with competitors and benchmarks. While no fund stays at the top consistently, opt for funds that have a history of appearing in the top quartiles for extended periods.
Fund House History: Choose fund houses with a consistent track record over five to ten years. A reliable history indicates the fund house's ability to manage investments effectively.
Expense Ratio: Consider the expense ratio, indicating the portion of your investment allocated to fund management. Lower expense ratios translate to higher take-home returns, making such funds preferable.
Financial Parameters: Analyze financial parameters like standard deviation, Sharpe ratio, alpha, and beta to assess fund performance. Higher standard deviation and beta imply greater risk, while a higher Sharpe ratio indicates better risk-adjusted returns.
Fund Manager Expertise: Assess the competency and experience of the fund manager in selecting appropriate stocks and building a robust portfolio. A skilled fund manager is crucial for effective fund management.
SIP or Lumpsum: Decide on the investment mode—Systematic Investment Plan (SIP) or lumpsum. SIP involves regular, typically monthly, investments, providing the benefit of cost averaging. On the other hand, lumpsum entails a one-time substantial investment.
SIP Advantage: Considered the best option for most, SIP allows cost averaging, offering more units during market downturns and fewer units during upswings.
Lumpsum Consideration: Suitable if you have surplus funds and prefer a one-time substantial investment.

ELSS Vs Other Tax-Saving Options

Explore various tax-saving instruments and their returns. Unlike fixed-return investments that may struggle against inflation, ELSS stands out by investing in equities with potential for higher returns. With a minimal lock-in period of 3 years, ELSS surpasses traditional options.

Investments	ELSS (Mutual Fund)	PPF (Government Scheme)	NSC (Government Scheme)	5 Year Tax-Saving FD (Bank)	NPS (Pension Scheme)
Type	Mutual Fund (Equity)	Government Scheme	Government Scheme	Bank Fixed Deposit	Pension Scheme
Lock-in Period	3 years	15 years	5 years	5 years	60 years (age)
Risk Level	High	Low	Low	Low	Moderate to High
Expected Returns	Market-linked	7.1% (Fluctuates)	7.7% (Fluctuates)	6-7%	Market-linked
Tax Deduction Limit (Section 80C)	Up to ₹1.5 lakh	Up to ₹1.5 lakh	Up to ₹1.5 lakh	Up to ₹1.5 lakh	Up to ₹1.5 lakh

Advantages of ELSS Mutual Funds

Shortest Lock-in: ELSS has the briefest lock-in of three years, offering more liquidity than tax-saving FDs (5 years) and PPF (15 years).

Higher Returns: ELSS can provide significantly higher returns compared to other tax-saving options. With an average 15% long-term return, a monthly investment of ₹12,500 for 20 years could accumulate ₹1.89 Crores.

ELSS Category Average Rolling Returns (%)

Period	Maximum	Minimum	Median	Mean
7-Year	28.61	4.81	14.01	15.18
10-Year	25.49	6.13	14.58	15.11
15-Year	21.05	8.24	15.16	14.93

Better Post-Tax Returns: Experience an impressive average return of over 21% in the 15-year span within the ELSS category. It's crucial to note that selecting a top-performing scheme in this category could yield returns surpassing the category's average. Utilize the ELSS maturity calculator to project potential corpus from different ELSS schemes.

Enhanced Post-Tax Returns: Unlock the benefit of a mere 10% tax on long-term capital gains (LTCG) from ELSS mutual funds if your total capital gain upon withdrawal exceeds Rs 1 lakh. If your annual profit is below Rs. 1 lakh, you're exempt from long-term capital gains tax.

Convenient: Ease into tax savings with ELSS mutual funds, even without a lump sum. Through systematic investment plans (SIPs), allocate a fixed monthly sum on a set date in your chosen ELSS scheme. This fosters a savings habit, instilling discipline without requiring a substantial year-end investment.

Convenience: Simplify the investment process with mutual fund apps like ET Money for a swift tax-saving mutual fund experience within two minutes. Streamline paperwork hassles during the hectic tax season.

Strategic Equity Exposure: Consider a higher exposure to equity (ELSS) if you can withstand market fluctuations, aiming for superior long-term returns crucial for building a robust corpus. Equities have the potential to outpace inflation and generate wealth over time. Prioritize investments based on goal requirements and asset-allocation suitability, not solely for tax purposes – ELSS funds align with all three criteria.

Tax Implications on ELSS

When you make money from ELSS, it gets treated similarly to other stock-related investments for income tax. If you sell quickly (short-term), you pay 15% tax on the gains. If you wait a while (long-term) and your profits are more than ₹1 lakh in a year, you pay a 10% tax on the extra amount.

Ways to Invest in ELSS Funds

Growth Option: If you choose growth, you won't get regular dividends. Your gains come when you sell. Remember, your returns depend on how the stock market is doing, and it involves some risk.
Dividend Option: With this choice, you get dividends from time to time. But be aware, these dividends are taxed based on your income. Also, if you get more than ₹5,000 in dividends, 10% of it is taken as tax (TDS).
Dividend Reinvestment Option: Here, you reinvest the dividends you get to increase your investment value. This can be good when the market is going up.

ELSS Funds FAQs

What are the ELSS funds?

ELSS, or Equity Linked Savings Scheme funds, represent tax-saving mutual funds in India. By merging the advantages of equity investments with tax deductions under Section 80C, ELSS establishes itself as a preferred choice for long-term investors. With a mandated 3-year lock-in period, these funds provide the potential for substantial returns alongside tax savings, enhancing their appeal to investors with a strategic, long-range approach.

Is ELSS good for tax saving?

An Equity-Linked Savings Scheme (ELSS) serves as a tax-saving investment according to Section 80C of the Income Tax Act, 1961. By opting for ELSS investments, you become eligible for a tax rebate of up to Rs 1,50,000 annually, leading to potential tax savings of up to Rs 46,800 per year.

Is ELSS good or bad?

ELSS funds present a favorable choice for investors aiming for long-term investment goals, seeking stock market exposure, and tax savings. With a range of ELSS funds at your disposal, it's crucial to conduct thorough research. Ensure your selected fund aligns with your financial plan, effectively contributing to both your investment objectives and tax reduction strategy.

Which is better SIP or ELSS?

An ELSS investment cannot be withdrawn within the initial three years under any circumstances. In terms of lock-in duration, SIP offers more flexibility compared to ELSS. Nevertheless, this flexibility might entail forfeiting tax deductions, as reducing the lock-in period requires giving up on tax benefits.

Is ELSS tax free after 3 years?

No, after the initial three-year lock-in period, ELSS gains are subject to a 10% tax on profits exceeding Rs. 1 lakh in a financial year.