How can you Save Tax with ELSS Mutual Funds

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The financial year is nearing its end and you may want to know the various investment options that are available to reduce your tax liability. Section 80C of the Income Tax (IT) Act, 1961 offers multiple tax-saving options for you. Some of these include public provident fund (PPF), fixed deposits (FDs), national pension system (NPS), national savings certificate (NSC), and equity-linked savings schemes (ELSS).

Options like PPFs and FDs offer guaranteed interest earnings; however, these are often lower and do not cover the inflation rate. Here are four reasons why ELSS is a better investment option.

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  1. Higher returns

ELSS funds invest in equities and other equity-related products. These may be highly volatile during the short-term but over the longer period, they outperform other investment avenues. Most investment options eligible for Section 80C deductions deliver about 9% annual returns. In comparison, ELSS delivers over 12% annualized returns over the long-term. You may argue that equity-linked unit-linked insurance plans (ULIPs) deliver similar returns. However, ULIPs have higher expenses and fund management costs that reduce their effective returns.

During the last three years, ELSS funds have delivered 18.69% annual returns. These have been 17.46% during the five-year period. The returns earned on different ELSS funds vary because every scheme follows distinct allocation criteria.

  1. Lower lock-in period

When you invest in an ELSS fund, you must stay invested for at least three years. In comparison, other eligible investments have longer lock-in periods. PPF has 15-year lock-in period and the lock-in period for ULIPs is five years. If you invest in NPS, you need to remain invested until you retire.

Although the lock-in period is three years, it is recommended you do not exit at the end of this time. When you stay invested in a well-performing ELSS fund for long, you may earn significantly higher returns.

  1. Tax-free earnings

ELSS funds are Exempt-Exempt-Exempt (EEE) financial products. This means that your capital investment is eligible for tax deductions under section 80C. Furthermore, the dividend income and maturity earnings are also tax-free. The interest on NSCs and FDs are taxable as per your slab. Furthermore, if the premiums on the ULIPs exceed 10% of sum assured, maturity proceeds are taxable.

  1. Financial discipline

You may choose a systematic investment plan (SIP) to invest in ELSS funds. This enables you to invest a smaller amount at periodic intervals and ensures you have no liquidity crisis. Furthermore, it instills financial discipline and eliminates the need to invest a huge lump sum at the end of the year to reduce your tax liability. Periodic investments are also beneficial in rupee cost averaging. This means you are able to buy more when the prices are lower and vice versa.

Tax benefits on ELSS funds

An amount of up to INR 1.5 lakh per annum is eligible for tax rebate under section 80C of the IT Act, when you invest in ELSS funds. These funds are equity-oriented schemes with over 65% of the corpus invested in equities and related products. Therefore, the dividend earned on ELSS is considered as long-term capital gains, which are tax-free. If you are not investing in such funds, start today.

When you invest through an SIP, it is important to remember that every installment is considered as a fresh investment. Therefore, to understand the tax benefits on your SIPs, you need to consider the three-year lock-in for each installment.

Understanding demat accounts

In 1996, dematerialization was made mandatory in India. Under this regulation, all physical securities were converted to an electronic form and credited to a dematerialization account, known as demat. These accounts eliminate damages, reduce delivery risks, make it easier to hold all your investments at a single location, make trading in odd lots possible, and offer several other benefits.

A demat account is similar to a regular savings bank account. It is used to hold all your investments in equities, bonds, certificates, mutual funds, exchange-traded funds (ETFs), and others, electronically. If you want to trade in the stock market, having this account is mandatory.

The procedure for online demat account opening is simple and quick. You must fill out an application form and attach your photograph and permanent account number (PAN) card copy. In-person verification is completed before the application is processed. After the application is processed, you will receive the account number and client ID. These are needed to access your account online. There is no minimum holding requirement when you open a demat account online.