ELSS

ELSS, or equity-linked savings scheme, is the only tax-deductible mutual fund and falls under section 80C of the Indian income tax act 1961. It is more inclined toward equities and linked securities. There is a mandatory lock-in period of three years. The ELSS fund allows investors to start investing in it with a SIP.

An investor can save up to 1,50,000 rupees in taxes through ELSS. Its lock-in period is the shortest among Section 80C investments. After completing the three years lock-in period, investors are not required to exit from the mutual fund; they can continue investing if they choose to do so.

• The full form of ELSS is the “Equity Linked Savings Scheme.” It is the only mutual fund that is eligible for tax deductions. It has a lock-in period of three years.
• Compared to other investment schemes like PPF and NSC, it has the potential to deliver high returns. But at the same time, it is prone to market instability.
• This investment allows both periodic and lump sum forms of payments.
• 70% to 80% of an equity-linked savings scheme is invested in equities; the fund focuses on long-term wealth creation.

The full form of ELSS is the "Equity Linked Savings Scheme.” ELSS funds are mutual funds that yield high returns. However, market volatility risks are higher with ELSS compared to regular mutual funds.

The equity-linked savings scheme is popular among investors because it has the shortest lock-in period—three years. Also, it delivers higher returns than other forms of investments —PPF and NSC. In addition, they are tax-deductible. ELSS offers tax-saving benefits under Section 80C of the Indian Income Tax Act.

70% to 80% of these mutual funds are invested in equities and are focused on long-term wealth creation. In India, long-term capital gains arising from equity-linked savings schemes are tax-free (up to 1 lakh rupees). But investors must pay a 10% LTCG tax after the lock-in period. These funds are either growth-oriented or dividend-based. Hence, investors get a regular income (even during the lock-in period).

It can be considered a smart investment—invest for three years and enjoy high returns. But it is also prone to market volatility; the investor must have a reasonable risk appetite. Other investment options like PPF and NSC have longer lock-in periods—fifteen years and six years, respectively.

An investor who makes a one-time investment in an equity-linked savings scheme mutual fund can withdraw money after the completion of 3 years. Alternatively, they can keep investing in the same fund beyond the mandatory lock-in period (if they choose to do so). With equity-linked savings schemes, investors can save up to 1,50,000 rupees yearly in tax deductions.

Let us look at some equity-linked savings scheme examples.

Example #1

In May 2022, SEBI announced: mutual fund investors would get more tax-saving investment options. In addition, SEBI ordered mutual funds to launch ELSS as passively managed funds.

Therefore mutual funds now have both actively managed equity-linked savings schemes and passively managed schemes.

These schemes will be based on an index comprising 250 top companies (based on market capitalization). The index will not have more than 25% exposure (debt instruments) to the same business group. Likewise, the index will not have more than 25% percent weight in the same sector.

Example #2

Let us look at a hypothetical to understand the instrument better.

Kevin has a reasonable amount of money and is looking to invest it in a financial instrument. He comes across equity linked savings scheme. He studies it and discovers the three-year lock-in period feature. Upon further due diligence, Kevin discovered that equity-linked savings schemes predominantly invest in inequities and offer high returns.

Kevin is convinced; he invests a lump sum. After three years, Kevin can sell his investment and exit the market with gained returns. Alternatively, he can continue investing for a longer period. But after three years, Kevin must pay a mandatory 10% tax for long-term capital gains.

• ELSS Tax Saving Benefits – As evident from the ELSS meaning, investors save in the form of reduced taxation. ELSS dedicates up to one lakh fifty thousand (from total taxable income). This feature is covered under section 80C of the Indian Income Tax Act.
• Capital Appreciation – It comes with capital appreciation options where investors seek the growth of their invested money. This option is available until the scheme is redeemed to pool funds out of the investment.
• Dividend – Another option of interest to investors is the dividend scheme. In this, the invested capital reaps the benefits of dividend payouts.
• Lock-in Period – Among all the popular investment products in the Indian market, the equity-linked savings scheme has the lowest lock-in period. The lock-in period for an equity-linked savings scheme is only three years. On the other hand, other products like fixed deposits and pension schemes have significantly higher lock-in periods.

• ELSS Tax Savings – These instruments are often called ELSS tax saving mutual funds because they come under 80C.
• Risk-Return Character – The associated risk increases since the fund invests in equities. However, it should be noted that equity-linked savings scheme has a track record of yielding better returns than many other investments.
• Ease of Investment – Investing in Equity linked savings scheme funds is easier than many other investment vehicles. Equity-linked savings schemes work on the same lines as SIP. Hence, it is possible for investors to either make periodic or lump sum payments into their investment accounts.

• These investments are subject to market risks—riskier than regular mutual funds.
• The lock-in period does not allow investors to withdraw their funds prematurely.
• Despite ELSS tax savings, they cannot be relied upon for higher monetary returns and savings; there are riskier options that offer faster growth.
• Investors can claim deductions against equity-linked savings schemes only when they have not used section 80C for other deductions. Tax benefit schemes like home loan interest fraction, provident fund, and life insurance policies are eligible for 80C deductions.

• Approximately 65% of equity-linked savings scheme is invested in equity-linked securities, but PPF or public provident fund is a retirement scheme offered by the Indian government.
• Equity-linked savings scheme offers high returns; PPF provides lower returns.
• An investor must be ready to face market volatility with a reasonable risk appetite if they want to invest in an equity-linked savings scheme. PPF is more secure.
• It has a lock-in period of three years. At the same time, PPF has a lock-in period of fifteen years.
• In an equity-linked savings scheme, investors must pay a 10% capital gains tax after the lock-in period. However, with PPF, tax on returns is exempted.
• Equity-linked savings scheme facilitates increased liquidity, but PPF reduces investors' liquidity.

This article has been a guide to ELSS and its meaning/full form. We explain it with examples, features, advantages, disadvantages, and a comparison with PPF. You can learn more about it from the following articles -

• Tax Planning
• Exempt Income
• Retirement Planning