Do you know investing and tax saving can go hand in hand? Yes, a Tax Saving Fund or Equity Linked Savings Scheme (ELSS) fund is a mutual fund scheme that invests primarily in equity or equity-related instruments. Besides this, they also offer tax-deduction of up to Rs. 1,50,000 from your annual income.
What if there is a scheme that has both the features- wealth creation and tax saving. This is where Tax Saving mutual funds or ELSS funds come in handy. Let us understand in detail everything about these funds.
What are Tax Savings or ELSS Mutual Funds?
Tax Saving funds are also called ELSS funds. ELSS stands for Equity Linked Savings Scheme. As the name suggests, ELSS funds are equity-oriented mutual fund schemes that invest a majority of their corpus in equity or equity-related instruments. These funds also provide an added benefit of tax deduction under section 80C of the Income Tax Act. Investors can save tax up to Rs. 1,50,000 in a financial year.
Tax Saving mutual funds have a mandatory lock-in period of 3 years. This means that the investors cannot redeem or withdraw money or units from these funds before the end of 3 years from the date of investment. These funds work as diversified or multi-cap funds as they invest across large-cap, mid-cap, and small-cap companies. However, their primary focus remains on investing in large-cap companies.
Features of Tax Saving Mutual Funds
Tax saver mutual funds are becoming very popular amongst investors due to their numerous benefits. Some key benefits of tax saver mutual funds or ELSS are as follows:
- Invests mostly in equities: Since it is, predominantly, an equity fund more than 80 percent of the fund’s money is invested in equity or equity-related instruments. From a tax point of view also they are treated as equity funds and are taxed as per equity funds. We will discuss how they are taxed later.
- Lock-in period of 3 years: There is a lock-in period of 3 years in all tax saving mutual funds. The 3 years is calculated from the date of investment in the fund. In this mandatory period of 3 years, investors cannot redeem their units or money. So investors should keep this in mind and those who might need money within the next 3 years should not invest in such schemes.
- Offers Diversification: Tax saver funds invest in equities of companies across different market capitalizations- large, mid, and small-cap. They also diversify across different themes and sectors.
- Eligible for Tax deduction: The amount invested in ELSS funds is eligible for tax deduction under section 80C of the Indian Income Tax act. However, the maximum amount that is allowed under section 80C is Rs. 1,50,000 per financial year.
- Returns treated as Long Term Capital Gains: The gains or returns earned on the Tax saving or ELSS mutual funds are treated as LTCG (Long Term Capital Gains) and taxed as per the provisions of the Income Tax Act. We will discuss the taxation of ELSS funds later in the article.
- No maximum limit on investment tenure: Though there is a minimum of 3 years lock-in there is no maximum limit on the tenure of your investment. This means that you can remain invested in the fund for whatever time you want.
Benefits of Investing in Tax Saving Mutual Funds
The main feature of an ELSS or a tax saver fund is its dual benefit of wealth creation and tax saving. But there are many other advantages of these funds that are discussed here.
- Savings on Taxes: The biggest advantage of Tax Saver Funds is that the principal amount invested is eligible for deduction under the Income Tax Act. You can save taxes (including cess) up to Rs. 46800 in a financial year by if you fully utilize the Section 80C provisions of Rs 1.5 lakh.
- Offers diversification in investments: Since these funds are diversified, it gives access and benefits that come with investing in different cap companies to the investors. They provide stability of large-cap companies and higher returns and growth potential of mid and small-cap companies. They also provide the benefit of sectoral diversification by allocating funds to different sectors.
- Better returns: The 3 years lock-in might seem a hurdle for certain investors but it could turn out to be a boon. Equity investments should be done from a long term perspective. Investors should give at least 5 to 7 years to get the maximum returns out of their investments. So a 3 years lock-in works in favour of the investors. Generally, it may not advisable to withdraw the amount from an ELSS fund immediately after the end of the 3 years unless you need the funds.
- Shorter lock-in period than other tax-saving investments: When compared to other tax saver instruments available in the market, an ELSS fund has a minimum lock-in period. Tax saving instruments, like NSC (National Savings Certificate), PPF (Public Provident Fund), and Tax Saver FD (Fixed Deposit), have a lock-in period of 5 years. Thus, ELSS funds work in favor of investors who cannot wait for such a long period or might need funds earlier.
- Can start investing with small amounts: Almost all the ELSS funds allow investors to start investing with as low as Rs. 500 per month. This is a great feature especially for newbie investors who do not have a large corpus at an early age.
- Allows investments through SIP: Another advantage of investing in an ELSS scheme is that it allows investment via the SIP route. This allows young investors to invest in small amounts, avail of tax benefits, and create long-term wealth at the same time. But you should bear in mind that each installment of SIP will have to complete a term of 3years before you can redeem it.
Taxation of Tax Saving Mutual Funds
The most crucial part of investing is the tax treatment on various instruments. Since ELSS funds are predominantly equity funds and have a 3 years lock-in, any returns on these funds are treated as long term capital gains (LTCG).
Long term gains up to Rs. 1,00,000 are exempt from tax. Gains over Rs. 1,00,000 are taxable at 10% under the provisions of the Income Tax Act. There is no indexation benefit available in this regard.
In other words, gains or returns on your ELSS funds of less than Rs 1 lakh are exempt from Income Tax. However, if the gains are more than one lakh, then you are required to pay LTCG tax at the rate of 10 percent without any indexation benefit.
Who Should Invest in Tax Saving Mutual Funds?
ELSS Fund or Tax Saver funds are equity-oriented mutual funds. Investors looking to take some exposure in equity markets and create long-term wealth, at the same time can invest in these funds. Investors, whose income is taxable and want to avail tax benefits, also can invest in these funds.
These funds are the most beneficial for investors that belong to higher tax brackets. Individuals in the highest tax bracket of 30% can benefit from tax-saving funds, as they can effectively save up to Rs. 46,800 worth of taxes including cess.
Advantages of investing in ELSS mutual fund
Here are some advantages of investing in ELSS mutual funds:
- Tax Savings: ELSS funds are the only type of Mutual Funds eligible for tax deductions of about Rs 1.5 lakh in a year by investing in the scheme.
- Lowest Lock-in Period Among Other Tax Saving Funds: ELSS funds have a lock-in period of only 3 years, which is the shortest among all tax-saving options.
- Lower Tax on Gains: Long-term capital gains (LTCG) from ELSS funds are taxed at 10% on gains above Rs 1 lakh per annum.
- The Benefit of Compounding: 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.
- Redemption Not Compulsory After 3 Years: After the lock-in period of 3 years is over, investors can choose to redeem their investment or continue holding it.
- Higher Returns: ELSS mutual funds invest up to 80% of their investible corpus in equity. Equity has great potential to earn high returns on investment since it invests in shares of various companies.
- SIP Option Available: Investors can invest in ELSS mutual funds through Systematic Investment Plans (SIPs) which allow them to invest small amounts regularly over a period of time.
- Safe and Transparent: ELSS mutual funds are regulated by the Securities and Exchange Board of India (SEBI) which ensures that they are safe and transparent investment options.
Top ELSS mutual funds to invest in 2023
Here are some of the top ELSS mutual funds that investors can consider investing in 2023:
1. Axis Long Term Equity Fund
Axis Long Term Equity Fund is a diversified equity linked saving scheme (ELSS) that invests in a mix of large caps and select midcaps.
| Particulars | Details |
| Fund manager | Mr. Jinesh Gopani |
| Launch date | 9th Dec 2009 |
| Minimum SIP investment | Rs. 500 |
| Expense ratio | 0.85% |
| Risk | Very High |
The returns provided by the fund as of 17th October 2021 are tabled below
| Period | 1 yr | 2 yr | 3 yrs | 5 yrs | 10 yrs |
| Returns | 5.97% | 3.59% | 18.24% | 8.84% | 15.79% |
2. DSP Tax Saver Fund
This is an Equity Linked Savings Scheme (ELSS). Investing in this fund allows you to avail a tax deduction on up to Rs 1.5 lakh annually under Sec 80C of Income Tax Act 1961. It invests in established as well as emerging companies across market caps to provide a combination of growth & stability.
| Particulars | Details |
| Fund manager | Mr. Rohit Singhania |
| Launch date | 18th Jan 2007 |
| Minimum SIP investment | Rs. 500 |
| Expense ratio | 0.80% |
| Risk | Very High |
The returns provided by the fund as of 17th October 2021 are tabled below
| Period | 1 yr | 2 yr | 3 yrs | 5 yrs | 10 yrs |
| Returns | 10.11% | 11.20% | 28.02% | 12.50% | 16.23% |
Frequently Asked Questions
- How much tax do mutual funds save?
Well, that depends on an individual’s total income. If an individual is in the 30% slab rate, the maximum tax (including cess) amount he/she can save is Rs 46800.
- Do mutual funds save income tax?
Yes, tax saver or ELSS mutual funds do help in saving tax. The principal amount is eligible for deduction under the Income Tax act subject to an upper cap limit of Rs. 1,50,000.
- Is there a minimum investment requirement for ELSS?
Yes. If you are investing in ELSS funds, then Rs 500 is the minimum amount that needs to be invested.
- Can I redeem my investment in ELSS after a year?
No. There is a lock-in period of 3 years if you are investing in tax saver funds. So, you can redeem your investments only after the 3 year period ends.
- Do I need to mandatorily redeem my investment after the completion of the 3-year lock-in?
No. there is no compulsion to redeem your investments after the completion of 3-year lock-in. To get the maximum benefit out of your investments, it is advisable that you remain invested for a longer period.
- What is the maximum amount that can be invested in these funds?
The minimum amount that is required to invest in ELSS funds is Rs. 500. However, there is no maximum limit to invest in such funds. One can invest any amount they like. But it should be noted that the income tax benefit is only up to Rs. 1,50,000.
