Are ELSS Mutual Funds Taxable After Three Years

The equity market is one of the most popular investment areas today. However, it also has a high probability of incurring losses or lower returns on the initial allocated amount. In such scenarios one could go for mutual fund investments which are comparatively lower at risk. There are funds that serves different purposes and ELSS mutual funds are one of them.

ELSS funds offer conditional tax exemptions alongside higher returns and mitigate financial risk. These benefits make it one of the most sought-after tax-saving strategies for beginners and veteran investors alike.

This article deep dives into the attached taxation policies and other related elements.

What are ELSS funds?

ELSS funds are essentially tax-saving mutual funds where most of the portfolio is invested into the stocks of exchange-listed companies. And while it shares some similarities with equity-linked or other types of mutual funds, the two should not be confused with each other.

For instance, ELSS funds come with a lock-in period of 3 years. Equity-linked mutual funds do not have any such conditions. Owing to this, ELSS funds offer relatively low liquidity, while mutual fund investments are withdrawable at any given moment.

Regardless, both schemes are taxed under Long Term Capital Gains (LTCG), which only arise if investments are held for over 12 months.

ELSS and equity-linked funds have expense ratios and exit loads. An expense ratio is a fee for the scheme’s annual management. Meanwhile, exit loads are charges that are incurred at the time of redemption of the investment.

However, ELSS funds shine when it comes to tax exemptions. Under Section 80C of the Income Tax Act (1961), investors can claim deductions of 1,50,000 INR. Moreover, the profit or income at the end of the 3-year lock-in period is considered to be LTCG. So, those returns are only taxed at 10% if the sum exceeds the value of 1,00,000 INR.

Taxation Policy on ELSS Funds

Before discussing tax exemptions on ELSS funds, it is vital to note a few critical factors. First, investment caps are eliminated at the end of the lock-in period. Second, the tax is levied without indexation benefits, meaning the principal sum is not adjusted for inflation.

Consider the example below to understand the taxation policy on ELSS investments:

Investor X puts in 3,00,000 INR in an ELSS fund. Post the lock-in period, they redeem the initial amount. Now, as per 80C, 1,50,000 INR is directly exempted from tax.

This leaves another 1,50,000 INR which is considered to be LTCG. As mentioned earlier, LTCG is taxed at 10% if the value exceeds 1,00,000 INR. Deducting that amount will leave Investor X with 50,000 INR.

Only that remaining sum is taxable. So, calculating it one final time, Investor X pays a tax of 5000 INR on an ELSS of 3,00,000 INR.

Taking this a little further, let’s look at a practical example of how tax exemptions under ELSS funds are more beneficial than other similar schemes.

Investor X puts in 1,50,000 INR in an ELSS scheme. Meanwhile, Investor Y allocates the same amount in an equity-linked fund. Putting it all together, the returns for both individuals will look like this:

Now, let's factor in tax exemptions under 80C for both parties. Based on that, the returns for Investor X and Y will be as follows:

The difference in returns for Investor X and Y comes from how tax exemptions effectively reduce the initial investment amount in Year 1 of an ELSS scheme.

For instance, if a person puts in 100 INR and receives an exemption of 20 INR, they only invest 80 INR. Considering that lower sum, the ROI is higher since the yields are calculated based on the entire amount.

Why Should You Consider ELSS Funds?

Apart from greater returns, ELSS funds offer several other benefits. These advantages become especially relevant compared to other 80C schemes, such as Public Provident Funds (PPFs) or Unit-Linked Insurance Plans (ULIPS).

Let’s examine some of the perks associated with ELSS investments:

Shorter Lock-In Tenure & Flexibility

Unlike PPFs or Employee Provident Funds (EPFs), ELSS schemes have considerably shorter lock-in periods. This makes them a far better choice for balancing long-term financial security with immediate monetary benefits.

Even so, investors can directly combine ELSS schemes with PPFs for greater versatility. In short, you diversify your portfolio to grow by significant margins while leveraging the stability of government-backed securities. This allows you to maximize your earning potential in ELSS investments without compromising on market security.

Protection Against Market Volatility

As implied at the very beginning, equity markets are highly volatile. That is precisely why ELSS schemes are so sought-after by investors.

For instance, the lock-in period helps prevent impulsive withdrawals or sales during sudden fluctuations. Apart from building investor discipline, this also aids in weathering stock price volatility. Since returns are higher over the long term, ELSS schemes benefit from market highs while providing a cushion to tide over short-term lows.

Low Financial Commitment & Systematic Investments

Best ELSS tax-saving Mutual fund investments can be as low as 500 INR every month. And while there are provisions for making lump sum allocations, this acts as an exceptional entry point for beginners.

For one, a lower financial commitment leaves room for first-time investors to focus on diversifying their portfolios. As such, this also enables individuals with regular income to build on their initial investment gradually.

In addition, ELSS funds offer Systematic Investment Plans (SIPs). So, you can decide on a designated monthly amount and leave it to compound naturally.

Wrapping Up

While ELSS funds can seem attractive, it is crucial to note that such schemes still have relatively higher risks than PPFs or fixed deposits. Yet, this is to be expected, considering the potential returns they offer.

Regardless, it is crucial to carefully examine all related details regarding such schemes before committing to them. That is where Choice India steps in. The platform streamlines your investment choices into one system while providing access to funds across all categories.

In addition, a dedicated channel offers financial guidance to ensure your market movements remain fool-proof.

Frequently Asked Questions

Are all mutual funds covered under Section 80C?

ELSS funds are the only mutual funds that benefit from the tax exemptions under 80C. Investing in ELSS schemes will enable you to claim a rebate of up to 1,50,000 INR. This would add up to 46,800 INR in tax savings annually.

Should you invest in multiple ELSS funds?

While it may seem appealing to go for as many ELSS funds as possible, it is advisable to stick to 2 or 3 at the beginning. This will help you manage and track your investments better. However, if you want greater diversification, ensure that you partner with a reliable brokerage firm to leverage all the potential benefits.

What is the difference between ELSS and standard mutual funds?

ELSS schemes are a variant of mutual funds. While both are excellent investment options, ELSS funds come with tax exemptions. Meanwhile, standard mutual funds do not offer any such benefits.

How can you redeem an ELSS fund after 3 years?

There are two primary ways of making a withdrawal from your ELSS investment. The first involves a lump sum redemption. The second is through a Systematic Withdrawal Plan (SWP), where you can draw fixed amounts at designated intervals.