Finance

What are Tax-Saving Funds? What is ELSS?

In India, most people invest with the objective of saving tax i.e. they wish to minimize their tax liability so they can retain as much income as possible for their consumption. The Indian government has used tax saving as an incentive to encourage people to invest.

This is done by allowing investors to claim deductions under section 80C of the Income Tax Act for investments made in selected schemes. Typically, you may choose to park your funds in tax-saving investment schemes such as Public Provident Fund (PPF), life insurance, National Savings Certificate (NSC), or tax-saving fixed deposits (FDs). These instruments provide assured returns upon maturity and are beneficial to reduce your tax liability.

However, these tax-saving investments fail to address an important objective of investment. The primary purpose of the investment is to enhance the value of the principal amount and create wealth over the long-term. Therefore, it is important to choose investments that provide positive returns after taking into consideration the rate of inflation. For example, the value of INR 100 would be less in the future than it is today; inflation erodes the value of money. The rate of return provided by traditional investment products is often lower than the inflation rate, which means the future value of investments actually erodes and becomes unprofitable in the long- run.

There is, however, a tax-saving investment that also has an excellent potential for higher returns. Tax-saving mutual funds are the latest addition to the list of tax-saving schemes. Known as Equity-Linked Savings Scheme (ELSS), this tax-saving mutual fund is a diversified equity-oriented fund, in which a majority of the investment is made in equity. Here are three features of ELSS.

  1. EEE scheme

ELSS is a unique product that allows you to indirectly invest in the equity market and claim deduction under section 80C of the Income Tax Act up to INR 1.5 lakh. ELSS funds qualify as an exempt, exempt, exempt (EEE) plan. This means the principal, profits or dividend, and maturity value are all exempt from tax.

  1. Lock-in period

ELSS funds have a three-year lock-in period. This means funds invested cannot be withdrawn during this period from the date of investment. If you choose to invest in such schemes through a Systematic Investment Plan (SIP), each installment is considered as a fresh investment and subject to the lock-in period.

  1. Lower investment value

When you invest in PPF, you need to at least make one contribution during each financial year. Similarly, the National Pension System (NPS) has mandatory annual contributions. In comparison, you may buy ELSS online for as low as INR 500 once and hold it until perpetuity without any further contributions.

Risks associated with ELSS funds

ELSS is a type of diversified equity mutual fund and therefore, is subject to risks. This means that if you make an inaccurate investment option, you cannot exit for at least three years from the investment date. Nonetheless, some of these funds have delivered exceptional returns in the past.

Types of ELSS funds

Like other types of mutual funds, ELSS plans are also available in growth and dividend option. The growth plan is a cumulative investment where your investments continue to grow until you exit. Under the dividend plan, the asset management companies (AMCs) pay out some portion of the Net Asset Value (NAV) if the scheme’s value increases. The dividend earned is tax-free.

You may also invest in dividend reinvestment ELSS funds. Here, the dividend is used to acquire more units. However, you must remember that each reinvested dividend is subject to the minimum lock-in period.

Benefits of ELSS funds

Compared to most other tax-saving investments, ELSS plans have several benefits. Here are three advantages.

  1. Tax benefits on principal, dividend, and maturity proceeds
  2. Because majority of the fund corpus is invested in equities, there is a potential for higher returns, which often exceed the rate of inflation
  3. Compared to other instruments like PPF, NPS, and tax-saving FDs, lock-in period for ELSS plans is the lowest

Professional management

When you buy ELSS online or offline, you have the advantage of your investment being professionally managed. Experienced professionals with years of investment experience invest the cumulative fund corpus. Additionally, a strong research team supports the fund managers. This ensures your money is invested in the best products to maximize returns.

Choosing the right fund to invest is crucial to ensure the highest returns and lowest risk. The Angel Wealth mobile app does this for you. ARQ, the technology-driven investment engine is the key highlight of the app. This automated investment advisory engine uses advanced quants and algorithms to deliver recommendations without human intervention or bias.

Download the Angel Wealth mobile app today and get the best recommendations on-the-go.