ELSS- A Tax Saving Investment in Mutual Funds

By: Doyouknow.IN | Views: 1912 | Date: 20-Dec-2010

There are various tax saving avenues under section 80C of the Income Tax Act. Most of them are apt for risk averse investors who are looking for investment in safe products. But for investors looking for equity exposure, the only two instruments available include ULIPs and ELSS. Here is a brief on ELSS.

There are various tax saving avenues under section 80C of the Income Tax Act. Most of them are apt for risk averse investors who are looking for investment in safe products. But for investors looking for equity exposure, the only two instruments available include ULIPs and ELSS. Here is a brief on ELSS.

What is an ELSS?      

Equity Linked Savings Scheme (ELSS) – a diversified equity mutual fund, is a tax saving product as investments in this instrument up to Rs. 1 lakh is deductable from taxable income under Section 80C of the Income tax Act.

Features

Minimum 80% investment is in equity. The balance can be in debt, money market instruments or cash. Thus this instrument is suitable with those with a risk appetite.
This product has a 3 year lock in period. Post the 3 year time horizon, the product is like any other open ended mutual fund for the investor. In case of early withdrawal, tax has to be paid by investors.
There is no upper limit on investment in an ELSS scheme. However, under section 80C of the Income tax Act, an amount up to Rs. 1 lakh in an ELSS scheme is deductable from taxable income.

Advantages

Eligible for Tax benefit: Investment in ELSS is deductable from taxable income thus reducing the taxable amount for the investor. In effect the investor saves tax at a rate dependent on his income slab.
Tax free returns: Income/ returns on ELSS schemes (dividend and on redemption) is tax free under EEE (Exempt- Exempt- Exempt) regime of the Income Tax Act.
Higher probability of better return: In order to avail of tax benefit, investors have to remain invested for at least 3 years. This gives the fund manager the opportunity to investment from a long term perspective as he does not have to worry about sudden redemption pressures i.e. there is more stability in terms of exit of funds. The fund manager can also keep small amount of funds very liquid thus ensuring that most of the AUM is invested at any point in time. Thus these funds tend to fetch better returns over other equity diversified funds. On an average, ELSS schemes have given returns upwards of 20% over the last five years.
Lower lock in period: In comparison to the various other investment avenues under section 80C of the Income tax Act, ELSS has the shortest lock in period. E.g. PPF- 15 year lock in.

Investment Options in ELSS

Investors in the ELSS product can opt for either the growth option or dividend option depending upon the need.

       Growth Option: Under the growth option, investors will not get any income during the tenure of the investment. At the time of redemption, investor will get lumpsum amount depending on the then prevailing NAV of the scheme.
       Dividend Option: Under the Dividend option, the investor can either opt for dividend payout or dividend re-investment.


Dividend Payout: Under this plan, if the scheme declares a dividend, the investor will receive dividend income. Suppose if Mr. Raj invested Rs. 20,000 at an NAV of Rs. 10 in an ELSS scheme, and a dividend is declared to the tune of 20%, he will get a dividend income of 4,000 which is not taxable and is not subject to any lock in though the original investment is subject to a lock in of 3 years.

Dividend Reinvestment:  Under this scheme, the dividend declared by the scheme is reinvested on behalf of the investor at the prevailing NAV on the day of dividend declaration.  The investor can claim additional tax benefits on the re-invested dividend amount. If Mr. Raj had opted for a dividend reinvestment plan, Rs. 4,000 which would be reinvested by the mutual fund scheme on behalf of Mr. Raj and the same can be treated as fresh investment and hence can be deducted from taxable income of year in which the reinvestment is done.

ELSS as an investment product offers twin benefits – capital appreciation and tax benefit. Assess your possible taxable income for the current year and find out the amount you need to invest in tax saving instruments. You need to start now as we are already into the 3rd month of this financial year. If you are have an appetite for equity investments, and want to invest in ELSS schemes,  the best way is through an SIP (Systematic Investment Plan) rather than investing a lump sum amount in a hurry, because then you tend to time the market. Regular investment through an SIP will help to tide over the sharp market fluctuations and volatile movement in the prices of shares as an SIP will average the cost price of units over a period of time. SIP provides you with the benefit of rupee cost averaging by buying higher number of units when the market has fallen and vice versa. Invest wisely to amass wealth.

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