Tax saver laws in India support savers with an exhaustive range of tax saving instruments like the Public Provident Fund, Tax saving Fixed Deposits, Equity linked Saving Scheme (ELSS), National Savings Certificate and several other options. However, without the professional advice frequently individuals make poor tax saving decisions with the tax saving choices that are available.
Individuals simply do not prioritise tax-saving instruments using the same approach as they would think about other investments and it is this view that is responsible for the widespread purchase of funds that offer investment goals instead of considering tax saving instruments as a part of their overall portfolio. This approach proves expensive in the long run as valued savings which can be compounded overtime get paid in tax.
For most investors, ELSS funds make an excellent entry product, where they get a ready mix of equity investing in mutual funds. ELSS fund are an open ended equity mutual fund which offer the greatest potential of generating wealth over the long term, these can be a good means for realising long term financial goals like children’s education fund and post-retirement corpus with contributions lesser than its fixed income alternatives. ELSS has the dual advantage of Tax-saving & potential for better returns than traditional Tax-saving Investment Products, this category of Mutual Fund Schemes is a recommended must have for every investor. These ELSS funds also have the lowest lock-in phase of just 3 years amongst all the options available in Section 80C. Additionally, there is no maximum limit to invest in the ELSS mutual funds and the returns are taxed at only 10 per cent. By investing Rs 1.5 lakhs each year, you can save taxes up to Rs 46,800. After a period of three years, gain from ELSS funds will be treated as long-term gains and taxed at 10 per cent for the gains above Rs 1 Lakh.
There are two other investment options that give equity linked returns; Unit-linked Insurance Plans (ULIPs) and the National Pension System (NPS). Though, ULIPs have a longer lock in period of 5 years, coupled with high costs and less transparency. The NPS is a retirement solution rather than a pure savings one. It has only partial exposure to equity and a very long lock-in period that actually extends till retirement age. There is currently no other three year lock-in product like the ELSS offered.
A word of caution is that Equity investments have higher risk over the short term. ELSS mutual Funds do NOT provide a guaranteed return, since they invest in equity shares of companies that fluctuate in the market. When you take inflation into account, bank FDs and similar deposits turn out to be sub-optimal because of inflation. If you are investing for the long term and age is on your side, you should never invest into guaranteed returns on your investments which typically offer a lower rate of interest.
Since the mandated lock in for ELSS Funds is 3 years. Experts suggest that you should invest in them with a minimum time duration of 5 to 7 years. Stock markets are very cyclical in nature and if your lock-in period finishes in a bear market or recession, then you will end up booking a loss. Hence in such situations it is recommended to stay invested in these funds for longer durations where the risk of investment is considerably lower and exit during a bull market. ELSS funds enforce a hard lock in, and so you cannot redeem funds from them before the 3-year lock in period has been completed.
To simplify your tax annual tax saving approach consider investing in an ELSS through a monthly Systematic Investment Plans (SIPs) through the year, this has advantages: first, they protect your investments in a market downturn, and second, you avoid making a quick lump-sum investment in March. Hence do not postpone your investment to the last quarter or month of the financial year in ELSS mutual funds. High valuations in the equity market at that time, if any, may cost you extra for the ELSS fund units. While investing in ELSS; instead of opting for the dividend option, opt for the growth option to benefit from the rule of compounding. Dividends are also taxable at the hands of investors as per their tax slab.
A general rule of thumb is to opt for the SIP option to spread your investments across the year and benefit from cost averaging during any market correction in the year. The minimum amount of SIP allowed for investing in an ELSS mutual fund is only Rs 500. A suitable practice for your tax saving plan is at the beginning of every financial year, estimate the amount you have left over after the Rs 1.5 lakh limit once legal deductions are made; divide this by twelve and start an SIP. Keep tax saving and investing simple to reap the benefits of investing over the long term !
The information, analysis and opinions expressed herein are for education purposes only and are not intended to provide specific advice or recommendations. This material is not an offer, solicitation or recommendation to purchase any financial products or services. Always remember that all investments carry some level of risk, including the potential loss of principal invested.