What is ELSS?

As an investor, you want to place your money in an investment that can help generate wealth, create regular returns and save taxes. In this regard, the ELSS, Equity Linked Savings Scheme, is one of the most effective investments that fulfill all three requirements. ELSS is a tax-saving mutual fund scheme that primarily invests in equity and equity-related securities. These mutual fund schemes can potentially generate high returns in the long run and have a short lock-in period of three years. ELSS investments are tax-exempt under Section 80C of the Income Tax Act, 1961.

Here is everything you should know about ELSS and how to save tax with ELSS:

What is ELSS?

ELSS is a mutual fund with most investments in equity and equity-related instruments. These mutual funds have a mandatory lock-in period of three years, which is comparatively shortest than other tax-saving investment options. ELSS mutual funds can offer high returns but are subject to increased risk due to market volatility.

Investments in ELSS up to Rs. 1.5 lakh exempt from taxes under Section 80C of the Income Tax Act, 1961. Recently, many investors have started investing in ELSS because of their high return potential and significant tax advantages. The returns from ELSS mutual funds get special tax treatment. Earnings from your ELSS mutual funds received after the expiry of the three-year lock-in period are considered as long-term capital gains (LTCG). They are taxed at 10%. However, ELSS returns up to Rs. 1 lakh is exempt from taxes. Hence, LTCG tax is applicable only over returns exceeding Rs 1 lakh.

What are the features of ELSS?

Here are some of the essential features of ELSS that you should know:

  • At least 80% of the total ELSS funds are invested in equity and equity-related schemes.
  • ELSS mutual funds create a diversified portfolio of equity investments spread across different sectors, themes and market capitalization – large, middle and small.
  • ELSS mutual funds have a mandatory tenure of three years. However, there is no maximum limit. If you do not fulfill the minimum lock-in period criteria, your tax benefits are reversed.
  • You can invest any amount in ELSS; there is no maximum limit. However, the mutual fund company sets a minimum limit, usually Rs 500.
  • You can invest a lump sum or choose the SIP (Systematic Investment Plan), where you pay a pre-agreed sum at a defined frequency for a specific period.
  • ELSS is one of the most influential investment options that offer inflation-beating returns and tax benefits.
  • ELSS mutual funds do not have an entry or exit load.
  • Average returns generated by ELSS mutual funds are between 10-12%, one of the highest tax-saving investments categories.

How to save tax with ELSS?

As specified, ELSS mutual fund investments up to Rs 1.5 lakh enjoy tax exemption under Section 80C. You can reduce your gross total taxable income by Rs by investing in ELSS. 1.5 lakh in a year. So, for those of you in the highest tax bracket, you can save nearly Rs. 46,800 (including 4% cess) annually in taxes. An ELSS is the one mutual fund scheme that is eligible for taxes benefits under Section 80C.

Apart from an exemption on investment, the returns from an ELSS scheme get preferential tax treatment. ELSS returns up to Rs. 1 lakh annually are free from taxes. Long-term capital gains from ELSS over Rs. 1 lakh are taxed at 10%.

The above tax benefits are applicable only if you file your taxes per the old tax regime. From FY2020-21, you can file taxes according to the old tax regime or the new tax regime. The old tax regime gives you tax exemptions under Section 80C, allowing you to reduce your gross total taxable income for the year. You also get the applicable deductions. However, in the new tax regime, there are no exemptions or deductions. Instead, the new tax regime levies lower, concessional tax rates rather than offering tax exemptions and deductions. In the new tax regime, there are no tax benefits available under Section 80C, Section 80D, Section 80TTA, etc.

Apart from being a wise tax-saving medium, ELSS mutual funds also support you in creating wealth over time. ELSS mutual funds primarily invest in equity, which has the highest potential of generating inflation-beating returns. According to Morningstar, ELSS mutual funds generated an average return of 13% in three years and 14% in five years. Such high returns coupled with applicable tax benefits make ELSS a smart investment choice.

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