What are ELSS mutual funds, and how do they help in tax savings?

What are ELSS mutual funds, and how do they help in tax savings?

Equity Linked Savings Schemes (ELSS) are a type of mutual fund that primarily invests in equity and equity-related instruments.
ELSS funds are one of the few types of mutual funds that offer tax benefits under Section 80C of the Income Tax Act, 1961.

Key Features of ELSS Mutual Funds

  1. Tax Savings: Investments of up to ₹1.5 lakh per financial year in ELSS are eligible for tax deduction under Section 80C.
  2. Equity Exposure: At least 80 percent of the fund's assets are invested in equity or equity-related instruments.
  3. Lock-in Period: ELSS funds come with a mandatory lock-in of 3 years, which is the shortest among all Section 80C options.
  4. Capital Appreciation Potential: Since ELSS invests in equities, it has the potential to generate higher long-term returns compared to traditional tax-saving instruments.

How ELSS Helps in Tax Saving

When you invest in an ELSS fund, the amount you invest (up to ₹1.5 lakh) can be deducted from your total taxable income under Section 80C. This helps reduce your overall tax liability.
Example: If your total annual income is ₹8,00,000 and you invest ₹1,50,000 in ELSS, your taxable income becomes ₹6,50,000. This can lead to significant tax savings depending on your income tax slab.

Other Benefits

  1. Shortest Lock-in: Compared to Public Provident Fund (15 years) and National Savings Certificate (5 years), ELSS has the shortest lock-in of 3 years.
  2. SIP Option Available: You can invest through Systematic Investment Plans (SIP), allowing you to invest small amounts regularly.
  3. Wealth Creation + Tax Saving: Unlike many traditional tax-saving instruments that offer fixed returns, ELSS also offers capital growth opportunities through market participation.

Taxation on Returns

  1. Dividends: If the scheme declares dividends, they are taxed in the hands of the investor as per their income tax slab.
  2. Capital Gains: Gains up to ₹1 lakh per financial year are tax-free. Gains above ₹1 lakh are taxed at 10 percent as per the long-term capital gains (LTCG) tax rule, without indexation benefit.

Points to Remember

  1. Returns from ELSS are not guaranteed as they depend on market performance.
  2. You cannot withdraw or switch your investment before 3 years.
  3. Each SIP installment is treated as a separate investment and is subject to its own 3-year lock-in.

Regulatory Compliance

  1. ELSS funds are offered only by SEBI-registered Asset Management Companies (AMCs).
  2. All fund houses must clearly mention the risk category, investment objective, and lock-in period in their Scheme Information Document (SID).
  3. AMFI mandates all distributors and advisors to follow proper suitability checks and risk disclosures before recommending ELSS to investors.

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