What is ELSS Under Income Tax Act? Understanding ELSS Tax Saving for Beginners

Introduction

When it comes to saving on taxes and growing your wealth at the same time, one option that stands out is the Equity Linked Savings Scheme (ELSS). If you’re a beginner looking to understand how you can benefit from ELSS tax saving, this guide is here to help you. We’ll break down the essentials, making it easy to grasp how ELSS works and how it can be a valuable addition to your financial planning.

What is ELSS?

ELSS, or Equity Linked Savings Scheme, is a type of mutual fund that primarily invests in equity (stocks). What sets ELSS apart from other mutual funds is its dual benefit: it offers the potential for high returns through equity investments and provides tax-saving benefits under Section 80C of the Income Tax Act, 1961.

In simple terms, by investing in ELSS, you not only have the opportunity to grow your money by investing in the stock market but also save on your taxes. This combination makes ELSS an attractive option for both new and seasoned investors.

How Does ELSS Tax Saving Work?

ELSS is eligible for tax deductions under Section 80C of the Income Tax Act, which allows you to reduce your taxable income by up to ₹1.5 lakh per financial year. This means that if you invest in ELSS, you can claim a deduction of up to ₹1.5 lakh from your total income, thereby reducing the amount of tax you need to pay.

As shown in the table above, the higher your investment in ELSS, the more you can save on taxes, up to the limit of ₹1.5 lakh.

Features of ELSS

1. Lock-in Period: ELSS has a mandatory lock-in period of 3 years, the shortest among all tax-saving instruments under Section 80C. This means that once you invest in ELSS, you cannot withdraw your money for three years.

2. Equity Exposure: Since ELSS invests primarily in equity, it has the potential to generate higher returns compared to traditional tax-saving instruments like Fixed Deposits (FDs) or Public Provident Fund (PPF). However, it also comes with higher risk due to market fluctuations.

3. Tax-Free Returns: The returns you earn from ELSS after the lock-in period are subject to Long Term Capital Gains (LTCG) tax. As of now, gains up to ₹1 lakh in a financial year are tax-free, and any gains above this limit are taxed at 10%.

4. Flexibility: You can invest in ELSS either through a lump sum or via a Systematic Investment Plan (SIP), allowing you to invest small amounts regularly.

ELSS vs. Other Tax-Saving Instruments

To understand how ELSS stacks up against other tax-saving options, here’s a comparison:

In this table, you can see that while ELSS has a shorter lock-in period and the potential for higher returns, it comes with higher risk due to its equity exposure. However, for those comfortable with some level of risk, ELSS offers a compelling combination of tax saving and wealth creation.

Who Should Invest in ELSS?

1. New Investors: If you’re new to investing and want to start with a tax-saving option that also offers good growth potential, ELSS can be a good choice. The 3-year lock-in period also helps instill investment discipline.

2. Young Professionals: With a longer investment horizon, young professionals can benefit from the compounding returns of ELSS, while also saving on taxes.

3. Those with Higher Risk Appetite: Since ELSS invests in equities, it suits individuals who are willing to take on higher risk for the potential of higher returns.

How to Invest in ELSS?

Investing in ELSS is simple and can be done through various platforms:

• Mutual Fund Houses: You can directly invest in ELSS funds through mutual fund companies.
• Online Investment Platforms: Several online platforms allow you to compare, select, and invest in ELSS funds.
• Through SIPs: You can start a SIP in ELSS, which allows you to invest small amounts regularly, reducing the impact of market volatility.

Steps to Invest in ELSS

Common Myths About ELSS

• ELSS is Only for Experts: While ELSS involves equity investments, it is managed by professional fund managers. Even beginners can invest in ELSS, especially with a SIP, to spread out the risk.
• ELSS is Very Risky: While ELSS carries risk due to its equity exposure, the 3-year lock-in period allows the investment to potentially recover from short-term market volatility, making it less risky over time.
• You Need a Lot of Money to Invest: You can start investing in ELSS with as little as ₹500 per month through SIP, making it accessible to everyone.

Conclusion

ELSS tax saving is a powerful tool for anyone looking to reduce their tax liability while also growing their wealth. With a short lock-in period, the potential for higher returns, and the flexibility to invest small amounts regularly, ELSS is an attractive option for beginners and seasoned investors alike. However, like all investments, it’s important to assess your risk appetite and financial goals before diving in. Understanding the basics of ELSS will help you make informed decisions and make the most of this tax-saving opportunity.