ELSS - benefit of equity investing along with tax saving

My article on ELSS in Mid-day Gujarati edition today.

Here is the link



Below please find the English translation

Mutual funds were not invented in India. However, we have some variants that one won’t find anywhere else in the world. These funds came into existence with an objective of promoting investments by retail investors into equity markets. We will talk about the two variations available only in the Indian market, viz., Equity Linked Savings Scheme (ELSS) and Rajiv Gandhi Equity Savings Scheme (RGESS).

While ELSS category has been in existence for many years, RGESS is a new entrant. Both are essentially equity mutual funds, but come with certain restrictions. Today, we will discuss about the merits and demerits of investing in ELSS.

Equity Linked Savings Scheme is a type of mutual fund that invests in equity shares and equity related instruments. An investor can invest upto Rs. 1,50,000 per year (As per the Union Budget 2014) to avail benefit of Section 80C of the Income Tax Act. The taxable income is reduced to the extent of amount invested (subject to the limit mentioned earlier) in ELSS. There is also a lock-in for a period of three years.

Since ELSS is a equity-oriented as defined by the income Tax Act, the dividends received from the scheme as well as long term capital are exempt from income tax as per the current provisions. Thus, apart from the reduction in tax, the investor also enjoys tax-exempt returns from the scheme. However, care must be taken to understand that these are equity funds and hence are subject to the volatility in the stock markets.

Does it make sense to invest in this scheme in spite of the price fluctuations?

First of all, the scheme comes with a lock-in of three years and hence the price appreciation, if any, would be considered long-term capital gain. As per the current laws, such long-term capital gain is tax exempt.

Second, due to the lock-in, an investor cannot exit the scheme before completion of three years. This means, there is no liquidity to the investor for a period of the lock-in. at the same time, this is not a close-ended fund and hence one can continue to stay invested in the scheme beyond the lock-in period. Since financial advisors recommend investment in equity mutual funds for long periods, the lock-in automatically makes the investor wait for at least three years before taking the money out of the scheme. A disciplined approach to using ELSS for tax saving can go a long way in helping the investor create wealth through the power of equity investing.

Third, since ELSS is an open-ended mutual fund scheme, one can start saving tax from April, the first month of the accounting year, instead of waiting for the last moment. SIP in ELSS ensures that the investor does not get burdened by tax planning in the last months of the year. It also ensures that the investor gets the benefit of Rupee cost averaging. (We discussed the benefits of SIP in one of our earlier articles).

At the same time, if an investor has already planned for saving tax through other means, viz. EPF, PPF, insurance premium, home loan EMI, etc., one may avoid ELSS and invest the money in an open-ended equity mutual fund without lock-in.

As a word of caution, ELSS is an equity linked investment and hence one must plan carefully before investing in this scheme.

Happy tax planning.

-       Amit Trivedi

The author runs Karmayog Knowledge Academy. The views expressed are his personal views. He can be reached at amit@karmayog-knowledge.com.