Indian Tax-Saving Funds For Beginners!

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Navigating the world of investments can be daunting, especially when it comes to tax-saving options in India. However, Indian tax-saving funds, also known as ELSS (Equity linked savings schemes), offer a straightforward and efficient way for beginners to kickstart their investment journey while simultaneously saving on taxes. These funds not only provide the potential for long term wealth creation but also offer tax benefits under Section 80C of the Income Tax Act. In this guide, we’ll delve into the basics of ELSS, helping beginners understand how they work and why they are an essential component of any investment portfolio.

Defining ELSS

  • Equity linked saving scheme or ELSS is a type of mutual fund scheme that primarily invests in Equity assets. Investments of up to 1.5 lakh made in ELSS mutual funds are eligible for tax deduction under section 80C of the Income Tax Act. 
  • The advantage ELSS has over other tax-saving instruments like tax-saving FDs, PPFs, and NSCs is the shortest lock-in period of 3 years. This means one can sell one’s investment only after 3 years, from the date of purchase and if one has an ELSS SIP (Systematic investment plan), each instalment has a lock-in period of three years, which means each of one’s instalments will have a different maturity date.

Let’s have a look at the essential features of ELSS:

  • Every ELSS fund invests at least 80% of its portfolio in a diversified mix of equity and equity-related instruments.
  • Funds are tailored to specific investment objectives and levels of risk.
  • One must keep one’s money invested in an ELSS fund for at least 3 years. This period serves as the lock-in period. Prematurely withdrawing one’s money before the lock-in period is not allowed. There is no limit to the amount of time one can remain invested in an ELSS fund after the three-year lock-in period. 
  • One can deduct up to ₹1.5 lakh of what one invests in an ELSS fund from the annual taxable income. While one can only deduct ₹1.5 lakh invested in an ELSS fund from the taxes, if a scheme is performing well, one can always invest more than that amount

It is important to note that all gains that the ELSS investments make are taxable as per the prevalent tax norms. At the time of writing, these include:

  • Short Term Capital Gain Tax (STCG): This is not applicable to ELSS funds since investors cannot withdraw for three years from the date of investment.
  • Long Term Capital Gain Tax (LTCG): Upto ₹1 lakh per year of LTCG is exempt from tax. Gains above ₹1 lakh are taxed at 10% plus surcharge and cess. Also, understand what are large cap, mid cap, and small cap mutual funds here

Benefits of Investing in ELSS

To identify the best tax-saving scheme for one’s needs, always consider the percentage of returns, lock-in period, etc. Let’s see how ELSS fares on these fronts.

Tax Savings

  • At the time of writing, ELSS funds are the only type of mutual funds eligible for tax deductions. As discussed above as well, one can avail tax deductions up to ₹1.5 lakh in a year by investing in the scheme. 
  • However, long term capital gains from ELSS above ₹1 lakh are taxable, still, these funds are one among the best tax-saving options. These offer higher post-tax returns as compared to other investment options like unit linked insurance plans (ULIPs) or public provident fund (PPF).

Short Lock-In Period

Once one invests in ELSS funds, they remain locked in for a period of 3 years. Other investments like public provident fund (PPF), employee’s provident fund (EPF), and national savings certificate (NSC) have a minimum lock-in period of 5 years or more and can provide long term returns.

Though the funds are locked-in for a period of 3 years, one can allow the funds to grow further by not redeeming it after the stipulated time. As these funds invest in equities, over a period of time, it can help one create higher returns. 

Small Investments

One can invest in ELSS schemes with as small an investment as ₹500 per month. This is also known as the systematic investment plan (SIP) in ELSS schemes. Thus, with minimum investments on a monthly basis, one gets the chance to see the money grow. 

Higher Returns

As these funds invest primarily in equities, one is likely to receive higher returns from the market.

Tax Implications on ELSS

Investments up to ₹1.5 lakhs in ELSS are eligible for deduction from taxable income in the financial year.  One can understand ELSS taxation with the help of the following example:

Suppose one has ₹2 lakh disposable taxable income in a given financial year, and one decides to invest in ELSS. Only ₹1.5 lakh out of this amount would be eligible for deductions, reducing the taxable income in that year (applicable only if one does not have any other tax-saving investments allowed for deduction under Section 80C of the IT Act).

One should also be aware of the capital gains tax that applies to returns generated by equity mutual funds. The returns from this fund are taxed like that from any other equity mutual fund scheme. However, since the units can’t be redeemed before 3 years of investment, only long term capital gains tax (LTCG) of 10% on gains above ₹1 lakh will be levied.

Suppose one has made a capital gain of ₹1.5 lakh on investment in this scheme at the time of redemption, LTCG of 10% would be levied on ₹50,000 in that financial year. ₹1 lakh in capital gains is exempted from taxation. The payable tax would be ₹5,000.

Who Can Invest in ELSS?

  • LSS is suitable for individuals in the early stages of their careers, offering the potential for growth while saving on taxes.
  • Investors seeking relatively low-risk options can consider ELSS as it provides a balance between risk and returns.
  • Ideal for those earning substantially from high-risk investments, ELSS offers a tax-saving avenue.
  • ELSS has no upper age limit, allowing individuals to start investing early in their careers or even after retirement.
  • Investors looking to diversify their portfolio can benefit from investing in the top-performing ELSS schemes, aiming for impressive returns over time.

ELSS Investment Process 

  • Investing in an ELSS fund with Share India is simple and convenient, whether on a smartphone or web browser.
  • The signup process is quick, requiring basic details for completing the KYC process.
  • Choose the type of fund and the investment amount, and proceed to make the payment effortlessly.
  • Stay updated on the fund’s performance by accessing one’s online portfolio anytime, anywhere.
  • With Share India, one’s investments are backed by advanced technology, ensuring safety and accessibility.
  • Sign in or create a new account now to start investing with confidence.

Conclusion

ELSS offers beginners a straightforward and tax-efficient way to start investing while saving on taxes. These funds provide the potential for long term wealth creation and tax benefits under Section 80C of the Income Tax Act. By investing in ELSS, beginners can kickstart their investment journey with ease, benefiting from both financial growth and tax savings.

Frequently Asked Questions (FAQs)