You have a choice of several investments under the Section 80 C’s capacious umbrella, in order to cut tax payments. Among these is ELSS, or equity-linked savings schemes. Here’s all you wanted to know about ELSS funds and why they are the best tax-saving investments.
What are ELSS funds?
ELSS funds are mutual funds that invest in the stock market. All equity mutual funds are not ELSS funds – a fund house has to get a particular scheme declared as an ELSS one. Each ELSS fund has a different way of stock selection, different reads on the market and economic trends, and different proportions of large-cap, mid-cap, and small-cap stocks. This, thus, makes each fund very different in terms of risk and return from the others.
It is true that ELSS involves taking higher risk that is inseparable from stock market investing. But there is a wide range of ELSS schemes and thus you can always find a fund that suits your risk profile. For example, if you do not want too much volatility, you can go for funds that stick to stable blue-chips or move quickly into cash when markets are uncertain. If you want higher returns and don’t mind risk, you can opt for funds that pick up smaller-sized companies instead of blue-chips. Further, equity risk reduces the longer you hold. The lock-in period already introduces risk mitigation and holding for longer than that will further reduce risk.
How do ELSS funds compare with other options?
Here, we’re going to restrict comparisons with other investment options under Section 80C. This is because options such as education expenses or home loan principal, which are expenses, cannot be compared to an investment.
|Product||Lock-in period||Where it invests||How you make returns||Tax on returns|
|Equity-linked savings schemes||3 years||Stock markets, across market capitalisations||Capital gains on appreciation in NAV||Nil on holding for over 1 year|
|National Pension Scheme||Until age 60||Combination of stocks, corporate debt, and government debt, depending on individual choice||Capital gains on appreciation in NAV||40% withdrawal tax-free, 60% taxed. At least 40% has to be converted to annuities, which are taxed at slab rates|
|Public provident fund||15 years||Forms a part of Govt borrowings and deployed as per Govt. requirements||Interest compounded annually, rates adjusted quarterly based on G-Sec rate||Nil tax on interest and on withdrawal|
|Employee provident fund/ Voluntary provident fund||15 years (employer contribution), or for period of employment (employee share)||Government and PSU bonds||Interest, rates declared at the end of each fiscal, depending on surplus generated||Nil tax on interest and on withdrawal|
|5-year bank deposits||5 years||Deployed as bank sees fit||Interest compounded quarterly, rates adjusted by individual banks depending on rate cycle||Interest is taxed at slab rate,TDS applies if annual interest for all deposits crosses Rs 10,000|
|5-year post-office time deposit||5 years||Forms a part of Govt borrowings and deployed as per Govt. requirements||Interest compounded quarterly, adjusted quarterly based on G-Sec rates||Interest is taxed at slab rate|
|National Savings Certificates||5 years||Forms a part of Govt borrowings and deployed as per Govt. requirements||Interest compounded annually, adjusted quarterly based on G-Sec rates||Interest is taxed at slab rate|
|Sukanya Samriddhi Scheme||Until account holder (i.e., the daughter) reaches 21 years of age||Forms a part of Govt borrowings and deployed as per Govt. requirements||Interest compounded annually, adjusted quarterly based on G-Sec rates||Interest and withdrawal exempt (as the daughter receives it)|
|Senior Citizen Saving Scheme||5 years||Forms a part of Govt borrowings and deployed as per Govt. requirements||Interest compounded quarterly, adjusted quarterly based on G-Sec rates||Interest is taxed at slab rate, TDS applies if interest crosses Rs 10,000 in a fiscal year|
Note that NPS has an additional deduction up to Rs 50,000 under Section 80CCD. Sukanya Samriddhi Scheme can be opened only in daughters’ names, while the SCSS can be opened only by aged 60 years and above.
A note on insurance premiums – insurance is not an investment. Insurance is only meant to provide a life cover or protection. Mixing insurance and investment will lead you to compromise both on the life cover and the return. Therefore, one term insurance plan – which gives you maximum cover for the lowest premium – will suffice. You can increase your sum assured as and when your income or lifestyle moves up.
How does Section 80C help reduce taxes?
Each financial year, the amount invested under the various Section 80 C options, or the amount spent under options such as home loan principal or children’s education, is deducted from your total income to arrive at the taxable income. Your tax slab is determined by the taxable income only, and you pay taxes on this. Therefore, Section 80 C provisions allow you to reduce tax outgo. For the highest tax bracket, the taxes saved through Section 80C is a maximum of Rs 46,350.
Of the options available to you, ELSS or tax-saving funds are the smartest investment options for the long term.
- Superior return: An ELSS invests almost its entire portfolio in equities. Over the long term, equity is the best asset class for generating inflation-beating returns. Options such as PPF, fixed deposits and the NSC are pure-debt instruments. EPF invests a very small portion in equity and this portion is only in the index – quality ELSS funds have delivered index-plus returns consistently. Debt-based investments over the long term deliver lower returns than equity, and have in the past failed to deliver more than inflation. Plus, there’s an element of fluctuation in these instruments too. Interest rates on these instruments are not fixed and they do not guarantee a particular level of return over the long term. PPF and NSC rates are pegged to yields on government securities and revised each quarter. If gilt yields drop, these instruments’ interest rates also drop. PPF rates had been at 8.8% in 2012, and is below 8% now. Banks also revise their FD rates in line with interest rate direction. The NPS, given its high debt component (only a maximum of 75 per cent can be parked in equity, depending on the plan you opt for), can see returns lower than ELSS schemes.
- No taxes at all: What is often ignored is that, on instruments such as the NSC and tax-saving deposits the interest earned is taxed, as mentioned in the table. It is only the principal that enjoys tax deductions. So, a tax-saving FD with an interest rate of 6.25% actually works out to 5.93, 4.96, and 4.32% in the three tax slabs, factoring in the tax on interest. Capital gains on ELSS are tax-free as long-term capital gains (long term is a holding period of more than 1 year) on equity-oriented funds are tax-exempt. Dividend from ELSS funds are also tax-exempt. Only the EPF and PPF do not suffer taxes at any point. But ELSS returns are anyway superior to provident fund returns. The complete freedom from any form of tax serves to enhance their attractiveness.
- Better liquidity: An ELSS investment will be locked in for three years. Beyond this, you can redeem part or whole of your ELSS at any time. Proceeds land directly in your bank account within three business days. PPF locks in for 15 years and allows only conditional withdrawal before that. Even so, withdrawal is neither quick nor easy. The EPF is usually locked in for the term of your employment. Tax-saving fixed deposits or the NSC are locked in for five years or more. The NPS is locked in until you reach 60 years of age, and again only allows conditional withdrawal. ULIPs are again five years and more in tenure, and carry surrender charges if redeemed before the policy period.
But there are several ELSS funds to choose from, each with a different risk-return profile. Log in to Select Funds to know which fund to invest in.