As you know, money saved is money earned. And by making certain strategic investments, you can save money on taxes every year. Equity Linked Savings Scheme (ELSS) or ELSS mutual funds is one such way. It’s an equity-oriented mutual fund scheme and the only type of mutual fund that offers tax benefits.

Tax benefit on ELSS mutual funds

If you invest in ELSS mutual funds, you are eligible for tax deductions of up to Rs 1.5 lakhs under section 80C of the Income Tax Act, 1961. This is applicable for individuals as well as HUFs. Such a deduction from your total taxable income allows you to save a huge chunk of money in taxes every year.

Tax-saving under section 80C for different tax slabs (inclusive of 4% cess):

Tax rate Tax saved
5% Rs 7,800
20% Rs 31,200
30% Rs 46,800

Lock-in period in ELSS mutual funds

Like with all other tax-saving instruments, ELSS mutual funds also come with a lock-in period. The lock-in period here is three years. You cannot redeem any of your holdings until this mandatory three-year period is over. ELSS mutual funds, however, have the shortest lock-in period when compared to other tax-saving instruments under section 80C.

Inflation-beating returns

When it comes to investing, it’s essential to consider the impact of inflation on your financial goals and portfolio. High returns are not of much value if they are not inflation-beating. ELSS mutual funds are a winner amongst all other tax-saving investments because they are the only ones in that category to provide inflation-beating returns.

This is because ELSS mutual funds primarily invest in equities (over 60%). This makes ELSS mutual funds a great investment option not just for tax-saving in the short run but also for wealth creation in the long run.

Other tax-saving investments

Here’s a quick comparison of ELSS mutual funds with other tax-saving investments available in India. This covers the lock-in period as well as the expected returns.

Tax-saving investment Lock-in period Expected returns
ELSS mutual funds 3 years 13 to 15%
Public Provident Fund (PPF) 15 years 7 to 8%
National Pension System (NPS) Until retirement 10 to 11%
National Savings Certificate (NSC) 5 years 6 to 8%
Tax saving bank fixed deposits 5 years 4 to 6%

As you can see, the expected returns of ELSS mutual funds are the highest among all popular tax-saving instruments. The lock-in period, too, is significantly lower than all other contenders.

What to keep in mind when investing

ELSS mutual funds are one of the best options available for planning tax savings while also working towards your other financial goals. Here are some things you should keep in mind when investing in ELSS mutual funds:

  • Lump Sum or SIP

As you know there are two ways to invest in mutual funds – either by a lump sum payment or through a Systematic Investment Plan (SIP). You can choose either mode since it won’t impact your tax-saving under section 80C. Generally, SIP is advisable if you don’t want to bear a higher risk. This is because the SIP mode allows you to invest multiple times through different phases of a business cycle. So you can alter the units you buy depending on the ups and downs of the market. This allows hedging of risk.

  • Investment horizon

If you’re thinking solely of tax-saving when investing in ELSS mutual funds, then you need a minimum of three years due to the lock-in period. However, if you also want to earn good returns and build your wealth, you should consider investing for at least five years. An investment horizon of five years allows your ELSS mutual fund investment to balance out the market volatility, thereby reducing the risk of investment.

  • Returns

As per the past trends and current market performance, you can see that the returns on ELSS mutual funds are high. But you have to consider that ELSS funds cannot guarantee returns since the performance of the underlying securities, primarily equity-oriented securities, is the determining factor. Hence, when compared to instruments like fixed deposits where you know the rate of interest you’re going to earn even before you make the investment, with ELSS mutual funds the returns are not certain.

  • Taxation

Once the three-year lock-in period is finished and you decide to redeem or switch out of your ELSS mutual funds, there will be tax applicable. All equity mutual funds held over a year attract a long-term capital gains tax at the rate of 10%. However, for gains below Rs 1 lakh in a financial year, this isn’t applicable.

Final thoughts

Considering all aspects, ELSS mutual funds are a winner when it comes to tax savings. With the shortest lock-in period, highest expected returns, and the dual benefit of tax-saving and wealth creation, ELSS mutual funds in your investment portfolio can work wonders.

To get started, you can either visit the fund house’s branch to fill out the KYC form or log onto their website. Alternatively, you can also go through aggregators. After you make your investment, you will receive a folio number and you can keep a track of how the fund is doing through the fund house’s website.