An Equity Linked Savings Scheme or ELSS refers to a diversified equity fund that invests primarily in stock market traded equities of various companies and offer tax saving benefits under section 80C of the IT Act of 1961. Apart from equities, ELSS schemes also invest smaller amounts in debt funds and money market funds, while a short lock-in period of 3 years that is less than all other tax saving options. These features make it a less risky alternative for people to invest in and grow their wealth. Investors are now increasingly considering ELSS as a preferred tax saving instrument because of its many key benefits. The following are some key reasons why you should prefer ELSS over the other popular tax saving options.
All-Round Tax Benefits:
One of the key benefits if you invest in ELSS mutual funds is that it is an EEE (exempt-exempt-exempt) scheme. This means that the principal amount invested, capital gains earned and even the maturity amount are all exempt from tax. However, the principal investment amount has a combined exemption limit of Rs. 1.5 lakhs under section 80C. However, there are no tax exemption limits on the tax-free capital gains and dividends. The returns are tax free as they amount to long-term gains under the Income Tax Act due to the 3-year lock-in period. Only PPF and EPF investors can avail an EEE tax treatment similar to ELSS.
Shorter Lock-in Period:
ELSS has the shortest lock-in period of 3 years among all the tax saving options that come under section 80C or any other section whatsoever. A shorter lock-in period means that you have better liquidity in comparison to other tax saving options. Despite having a shorter lock-in period, its exposure to the equity market allows fund managers to earn higher returns that have historically exceeded inflation levels. The lock-in period also becomes an advantage for both the investor and fund manager as it counters market volatility from short-term investments. For your reference, PPF has a lock-in period of 15 years, NSC of 6 years, NPS till retirement and bank fixed deposits that are eligible for tax deduction have a lock-in period of 5 years.
Flexibility of Investment Amount:
You can start investing in ELSS with as small an amount as Rs. 500 and invest up to whatever amount you desire. However, the maximum tax-free limit of Rs. 1.5 lakhs under Section 80C will apply. There is also a broad range of options available to you to invest as all AMCs in India have their own ELSS mutual funds on offer. There is also the additional advantage that you can make small or large investments any number of times in the year unlike PPF or other schemes where the number of yearly deposits you can make is limited.
Both SIP and Lump Sum Investment Options:
You can invest in ELSS schemes via the SIP mode as well as with a lump sum amount. In the former case, the lock-in period of 3 years will apply to each block of units separately. Though people may take this as a disadvantage, it actually brings in fiscal discipline along with good returns. You also get the benefit of rupee cost averaging when subscribing to SIP such that you no longer have to time the market. Moreover, holding an ELSS for the long term will give you much better investments than what you can expect from a PPF, EPF or a tax saver FD.
Growth and Dividend Option:
As an investor, you have the freedom to choose either the growth or dividend option available under the individual scheme. The growth option allows the fund to grow until you redeem it, whereas, under the dividend option, you get back some amount of money if the Net Asset Value (NAV) of the fund has increased. This way you can enjoy tax-free dividends at intervals. Some ELSS funds also offer dividend reinvestment plans in which the dividend is spent on buying more units of the fund. However, dividend reinvestment is not preferred by most investors because every time you buy new units with the dividend earned, they get locked for an additional 3 year period. The dividend reinvestment plan does not allow you to completely exit from the scheme because when you are about to leave the scheme there might still be some units locked in it.
Considering the many benefits that have been mentioned earlier, it is little wonder that ELSS tax saver schemes have emerged as a popular alternative to traditional tax savers and this popularity is expected to keep growing for the foreseeable future.