What is an equity tax saving mutual fund?
Planning your taxes is important, and we recommended that you start at the earliest to increase your tax saving. Under Section 80C of the Income Tax Act 1961, a tax payer is allowed to claim deductions in the taxable income and ELSS mutual funds are a popular investment that is used to claim tax benefits. With tax savings in mind, lets understand the meaning of ELSS funds.
- Simply put, ELSS mutual funds are equity diversified funds where investors can gain from capital appreciation as well as enjoy tax benefits.
- An Equity Linked Savings Scheme or fund is one where a major corpus of the fund is invested in equities. As by definition, a major part of the ELSS mutual fund is invested in equity, the fund benefits from returns in the equity markets.
- The ELSS funds have a lock-in period of 3 years starting from the date of investment. This implies that no part of the ELSS investment can be removed from the fund for a period of three years from the investment date. After a medium term of 3 years, the ELSS investment can be sold and the investor can enjoy the tax benefits as well as the additional returns.
- The equity tax saving fund comes with dividend and growth options. In the growth option, the investor gets a lump sum payment of accrued profits after 3 years while in the dividend scheme, the ELSS investors get a dividend income as the fund declares a dividend even during the 3 year lock-in. For purposes of Income Tax, the investor can claim an ELSS investment of up to Rs.1 lakh as deduction under Section 80C for a financial year.
- ELSS mutual funds, like any other investment, require detailed investigation. The investor should sensitise himself or herself to the investment approach of the particular ELSS funds that he or she is considering. When you are taking an investment decision, make sure that you also look at the long-term performance of the ELSS fund. Another key indicator is the expense ratio of the fund. The expense ratio is the annual fee that the fund manager charges and is expressed in a percentage. It is the percentage of the asset value that is deducted each fiscal year.
- With the understanding of what an ELSS fund is, investor like you also needs to know that an equity tax saving mutual fund has the lowest lock-in period in comparison to other tax saving instruments. The Public Provident Fund or PPF has a lock-in period of 15 years whereas a National Savings Certificate has a minimum lock-in of 5 years. Bank fixed deposits become eligible for tax deduction after a lock-in period of 5 years.
- An ELSS fund is based on market risks and the investor should, before investing, understand his or her risk appetite. As all ELSS investments are typically equity investments, any fluctuation in the market will reflect in the value of the ELSS fund. This is obviously subject to the equity market that the ELSS fund is linked to.
- Under the proposed Direct Tax Code [DTC] that seeks to simplify direct taxes, ELSS investments are no longer awarded tax benefits. However, the DTC is only in the draft stage and there is time before the same is finalised as more changes in the DTC are expected.
- For an investor who can take high risk, typically a young investor, ELSS funds are the right fit. Historical data shows that the equity market earnings have typically outperformed bank interest rates over a long period. For someone who is looking to invest over a long-term period ELSS investment is ideal.
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