Most people investing in mutual funds look for good returns and income tax benefits. ELSS mutual funds provide this ideal combination. This blog will serve as a complete guide on ELSS mutual funds.
What are ELSS mutual funds?
An equity-linked savings scheme (ELSS) is an open-ended scheme that invests a minimum of 80% of its total assets in equity and equity-related instruments (in accordance with the Equity Linked Savings Scheme, 2005, notified by the Ministry of Finance). The scheme has a lock-in period of 3 years and provides tax benefits at the time of investment under Section 80C of the Income Tax Act.
Features of the ELSS
Some of the features of the ELSS include the following:
- High risk, high return potential product
The ELSS invests a minimum of 80% of its total assets in equities. Equity markets, by nature, are volatile. During events such as a pandemic, war, inflation, recession, political uncertainty, etc., markets can fall sharply in the short term, leading to losses for the investors. However, markets tend to overcome short-term volatility and losses in the long run and reward investors handsomely.
As ELSS mutual funds are high risk, high return potential products, they are suitable for investors with an aggressive risk profile. So, if you have an aggressive risk profile with a long-term investment horizon of 5 years or more, you may consider investing a portion of your overall investments in ELSS.
- Lock-in period
The ELSS mutual funds come with a lock-in period of three years. However, this is a short lock-in period compared to other products under Section 80C, such as a bank fixed deposit with a five-year lock-in, Unit Linked Insurance Plan (ULIP) with five-year lock-in, and Public Provident Fund (PPF) with a 15 year lock-in period, etc.
The lock-in period also applies to every systematic investment plan (SIP) installment. For example, if you start a monthly SIP for five years (60 installments), the three-year lock-in period will apply to each of the 60 SIP installments.
- Power of compounding
In the long run, equities have the potential to generate inflation-beating high returns. The power of compounding works in the long run. You need to give time to your ELSS investments to benefit from compounding. As ELSS mutual funds invest majorly in equities, they have the potential to create wealth for investors. ELSS mutual funds are a good investment option for long-term financial goals such as accumulating a fund for a child’s higher education or building your own retirement fund.
- Income tax benefits at the time of investment
ELSS mutual funds offer tax benefits at the time of investment. An investor can claim a deduction under Section 80C of the Income Tax Act. The maximum deduction that you can claim in a financial year is the amount invested or Rs. 1,50,000, whichever is lower.
The maximum limit of Rs. 1,50,000 in a financial year has to be shared among ELSS mutual funds and other investment products such as Public Provident Fund (PPF), life insurance, National Savings Certificate (NSC), etc.
ELSS has the potential to give high returns in the long run. Other tax saving products such as National Savings Certificate (NSC), Public Provident Fund (PPF), Senior Citizen Savings Scheme (SCSS), Sukanya Samriddhi Account (SSA), etc. belong to the fixed-income category. If we compare the long term of these fixed income products with ELSS, then the returns from ELSS are far superior.
- Taxation at the time of redemption
As ELSS mutual funds invest more than 65% of their total corpus in equities at all times, they are taxed as equity funds. If you sell your equity mutual fund holding within 12 months of purchase, the profit will be classified as short-term capital gain (STCG). The STCG tax will be levied at 15% flat.
If you sell your equity mutual fund holding after 12 months of purchase, the profit will be classified as long-term capital gain (LTCG). In a financial year, the first Rs. 1 lakh LTCG will be exempt from taxation. On the incremental gains, the LTCG tax will be levied at 10% without any indexation benefit.
Performance of top ELSS mutual funds
Let us look at the performance of the top five ELSS mutual funds.
| Scheme name | AUM (Rs. crores) | 1-year | 3-years | 5-years |
| Quant Tax Plan | 1,316 | 15.33% | 34.18% | 22.30% |
| Mirae Asset Tax Saver Fund | 11,962 | 6.18% | 18.99% | 16.33% |
| BOI AXA Tax Advantage Fund | 595 | 4.72% | 21.42% | 15.85% |
| Canara Robeco Equity Tax Saver | 3,629 | 5.51% | 18.00% | 15.39% |
| IDFC Tax Advantage (ELSS) Fund | 3,741 | 10.43% | 18.51% | 14.20% |
Note: The returns are as of 07th June 2022. The returns are for direct plans with growth option. The one-year returns are absolute. The three and five-year returns are CAGR. The funds have been ranked based on five-year performance.
How much tax can you save with ELSS mutual funds?
Depending on the tax bracket that you fall in, your tax savings from investing in ELSS will vary.
| Investment amount | Income tax bracket | Tax saving before 4% cess | 4% cess saving | Total tax savings |
| Rs. 1,50,000 | 10% | Rs. 15,000 | Rs. 600 | Rs. 15,600 |
| Rs. 1,50,000 | 20% | Rs. 30,000 | Rs. 1,200 | Rs. 31,200 |
| Rs. 1,50,000 | 30% | Rs. 45,000 | Rs. 1,800 | Rs. 46,800 |
As seen in the above table, if you are in the 10% tax bracket, your total tax savings will be Rs. 15,600 if you invest the entire Section 80C benefit amount of Rs. 1,50,000 in ELSS mutual fund. Similarly, investors in the 20% tax bracket will have a total tax saving of Rs. 31,200. Finally, people in the 30% tax bracket will have a maximum tax saving of Rs. 46,800.
ELSS mutual funds: Ideal combination of good returns and tax benefits
In the above section, we have seen how the top 5 ELSS mutual funds have given five-year returns in the range of 14% to 22% CAGR. ELSS mutual funds are a good investment product for long-term financial goals such as planning for a child’s higher education or your own retirement. ELSS provides an ideal combination of tax benefits and good returns.
