EQUITY LINKED SAVINGS SCHEMES (ELSS) BEING AN EQUITY ORIENTED FUND, LONG TERM CAPITAL GAINS ARE ALSO TAX FREE IN THE HANDS OF THE INVESTOR

 

In its first Budget after coming to power, the Naren dra Modi-led government increased the section 80C limit for tax deductions from income under the Income Tax Act by Rs 50,000 per annum for individual taxpayers to Rs 1.5 lakh. While this increase in the tax deductions was the most significant incentive for individual tax payers, there were some additional incentives which too were aimed at higher saving and investing.Under section 80C, taxpayers enjoy income tax exemptions to a certain limit if they invest or save using some governmentspecified investment products which include equity linked savings schemes (ELSS) of mutual funds, provident funds, by repaying home loan principal amount, by buying life insurance etc. In the same Budget, the finance minister also increased the maximum limit to save through PPF to Rs 1.5 lakh and home loan interest exemption to Rs 2 lakh.

According to financial planners and advisors, ELSS (also called tax savings funds) floated by mutual fund houses are one of the best tax saving options for investors. This is because in the long term they have the potential to generate an average annual return of 12% or more, these funds help a taxpayer save on taxes under income tax rules and has a lockin of just three years. The returns from all ELSS are also tax free while the costs are around 2.5% per annum, one of the lowest for comparable products. In comparison most of the other tax saving options can barely generate as high a return, costs for those instruments are mostly higher, and returns on some of those products are taxed on redemption. A combination of some of these factors makes such products unattractive in comparison to ELSS. In comparison, in ELSS, the returns as well as the principal, becomes free if there is no withdrawal for one year.

So suppose a taxpayer, after taking care of his contributions to provident fund, home loans etc, is still left with about Rs 60,000 to invest to save taxes under section 80C, financial planners usually advice such clients to go for one or more SIPs in ELSS funds, aggregating Rs 5,000 per month. This way the taxpayer's yearly contribution is Rs 60,000. At about 12% average annual return, in 10 years, this can grow to be a Rs 11.6lakh corpus. And in 20 years, this can grow to a corpus of close to Rs 50 lakh.

WHAT ARE ELSS?

ELSS are equity mutual fund schemes which at any given time invest at least 65% of its total corpus in stocks. The balance could be invested in non-equity assets like debt, money market instruments, cash and cashequivalent. Also only those equity-oriented schemes which are recognised by the government to be tax saving schemes, can allow tax incentives under the income tax rules.

Financial planners and advisors say that ELSS derive their power from being market-linked, which also make them unique among tax savings instruments. A look at other tax saving instruments like PPF and NSC show that these are fixed on an annual basis by the government.ELSS also come with the shortest lock-in of three years while the minimum lock in for other tax sav ing instruments is five years.

Additionally, ELSS being an equity oriented fund, long term capital gains are also tax free in the hands of the investor.In case one chooses the dividend option instead of the growth option, dividends paid by these schemes are also tax free for investors.

Financial analysts often advice their first time investors in equity funds to start through investing ELSS, and through the systematic investment plan (SIP) route. This is because such aa approach inculcates a habit of saving for the long term. This also helps build a corpus that becomes available after a fixed interval of time.

Returns from ELSS have also been high. According to some calculations, if an invrestors had put in Rs 70,000 in March of every year in one of the best performing schemes, the corpus would have been nearly Rs 1.70 crore. In comparison, the same investment in a competitive product would have fetched the person about Rs 33 lakh, that is less than 20% of his investment in ELSS.

Investors in ELSS should remember that since these funds invest in equities, so there are some chances of these investments losing their value. However, over the long run, there is very low chance of a loss, financial advisors say.

How to invest in ELSS?

To invest in an ELSS, one should identify the fund house, fill up the relevant forms along with the KYC details. One of the best ways to invest in any mutual fund for the long term (and that is not only limited to ELSS) is through the SIP route. So along with the ELSS form, the investor should also fill up the form for SIP mode of investing. Along with these the investor should also give a mandate to his bank for electronic debit of his bank account for the SIP amount (also called an ECS mandate).Once all these forms are is in place, investments in the ELSS selected by the investor should start and continue without any problem.

Giving a ECS mandate for SIP makes the process of investing simpler as the pre-fixed amount of money for the SIP is deducted from the investor's bank account without any human intervention. This also brings in financial discipline for investors and for fund houses the costs also come down substantially.

Some of the top fund houses are also offering investors, who are already KYC compliant, to invest in moist funds from the fund house online. This process also takes care of the SIP mandate.However, the current rules do not allow online registration of nominees. For that investors have to send a separate form.

Benefits of SIP

There are some additional benefits in one decides to go for an SIP investment. This route allows one to reap the benefits of rupee-cost averaging.This is a process where the investor would buy more the ELSS fund's units when the market is low (assuming that the NAS of the ELSS will also be low), but less number of the fund's units when the market is rallying and prices are high (again assuming the fund and the market has a direct correlation). By following such a process, over several months, the investor will be able to average out his cost of acquisition of the fund. In comparison if the investor invests a lump sum, he may not get the best price to invest in the scheme.