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Pros and Cons of ELSS Tax Saving Mutual Funds

27 May 2022

The number of people taking advantage of the Equity Linked Savings Scheme or ELSS has steadily risen. Due to the increase in popularity, more people want to know the advantages and disadvantages of ELSS funds.

Besides the obvious drawback – 3 year lock-in, there aren’t many drawbacks to these ELSS funds. Read the full article to know all the pros and cons of ELSS.

Advantages of an ELSS Fund

1) Tax Savings

Amount invested in an ELSS fund is available for a tax deduction to the extent of ₹150,000 for the current financial year under section 80C of the Income Tax Act. This is the only scheme that allows investors to save on tax while earning high returns from investment in equity funds.

2) Lowest Lock-in Period Among Other Tax Saving Funds:

ELSS has a lock-in period of only 3 years, as compared to a minimum of 5 years for other tax-saving options. This period is the lowest in comparison to other tax saving options such as 15 years in a PPF or 5 years in a Fixed Deposit option. Thereby ELSS provides higher returns with the lowest lock-in period.

3) Lower Tax on Gains

An ELSS fund is invested for a minimum period of 3 years. Any gains from the sale of ELSS funds are therefore long-term in nature. 

According to the present law, gains above ₹ 1,00,000 shall be taxable at the rate of 10%. In contrast, short-term capital gains are taxed at the rate of 15%. Thus, ELSS funds entail lower tax expenses automatically.

4) The Benefit of Compounding

It is generally advised to invest in equity funds for a long time horizon, spanning 5-10 years. ELSS funds by virtue of the lock-in period bring about a disciplined long-term investment by default. In this process, it helps the investors benefit from the power of compounding in the long run.

5) Redemption Not Compulsory After 3 Years 

If the investors are happy with the returns from the respective ELSS fund, they may choose to continue. Redemption is not compulsory after a period of 3 years. It is only a minimum investment duration, however, there is no maximum investment duration.

6) Higher Returns

Since ELSS funds invest in equity schemes, the returns are higher (15-20%) compared to other tax saving options (generally, 7-10%). Over a 3 year period, the benefit of compounding coupled with returns from equity provides higher returns for investors.ELSS provides returns in the range of 15-20% generally. This is highest among other tax saving options such as PPF, and FD over 5 years, among others.

7) SIP Option Available

 

While investing in ELSS, investors may choose to go with the SIP option. It allows the investor to invest a fixed amount at regular/ periodic intervals.

This allows the salaried class to invest a fixed sum from their savings periodically, generally each month.

8) Safe and Transparent:

Investing in mutual funds is very transparent. All mutual funds companies come under the purview of SEBI and they need to make necessary disclosures.

Disadvantages of an ELSS fund

1) Limited total benefits 

Tax benefits for a particular financial year are available only to the tune of ₹150,000 under section 80C, irrespective of the total amount of investment in an ELSS fund. For example, if an investor invests ₹10,00,000 in an ELSS fund in a current financial year. The benefits would be limited only to ₹1,50,000.

2) Tax Benefits are Limited

Tax benefits up to ₹150,000 are inclusive of other benefits under section 80C such as PPF, life insurance, and repayment of home loan principal, among others. This means, that if these deductions already amount to a sum of ₹150,000 then no deduction for an investment in the ELSS scheme shall be available to the investor.

Investment in ELSS should be a function of an investor’s investment objective, his risk-return appetite, and his investment duration, among others.

Features

Lock-in:

Unlike other mutual fund schemes, ELSS is different in the sense that there is a minimum lock-in period of 3 years in any/all ELSS schemes. Under ELSS schemes, pre-mature withdrawal is not allowed before the completion of the lock-in period.

Tax Benefits:

Although there is no upper ceiling for investing in an ELSS scheme, however tax benefits for ELSS are available to the tune of ₹ 150000 under section 80C of the Income Tax Act. There is no such tax saving or benefit available for other mutual fund schemes.

Investments in ELSS can be made in lump-sum or through a Systematic Investment Plan (SIP). Investment via SIP helps to average out the cost of the investment and involves shelling out of lesser money at one time. However, it is important to note that each SIP shall have a lock-in of 3 years.

Happy investing!

Disclaimer: The views expressed here are of the author and do not reflect those of Groww. 

 

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