Common misconceptions about tax saver mutual funds (ELSS)

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ELSS, or Equity Linked Savings Scheme, is a type of mutual fund where at least 80% of the underlying assets are equities or equity-related securities. ELSS, also called tax saving mutual funds, is eligible for tax deductions of up to Rs. 1.5 lakh per annum under section 80C of the Income Tax Act, 1961.

What are the benefits of ELSS?

  • Comparatively higher returns than other tax-saving investments like tax-saving fixed deposits (FDs) and Public Provident Fund (PPF)
  • One of the lowest lock-in periods among tax-saving investments
  • Gains on ELSS are considered Long Term Capital Gains (LTCG) and taxed at 10%, lower than Short Term Capital Gains (STCG) that are taxed at 15%
  • Diversification in the basket of underlying equity securities negates the risk of market fluctuations. Investors have no choice over the types of underlying assets in other tax-saving investments, like PPF
  • Investment in ELSS in smaller amounts is possible through SIP mode

What are the limitations of ELSS?

  • ELSS investments are not intended for the short term as there is a lock-in period
  • Investment over Rs. 1.5 lakh in ELSS will not be eligible for tax deductions

Common myths about ELSS

  1. Invest in any ELSS fund. They’re all the same!

Like other mutual funds, ELSS also has varieties including large-cap, mid-cap, and small-cap. Therefore, you must invest in those ELSS mutual funds that suit your risk appetite and investment goals.

  1. ELSS is a tax-free investment

While ELSS is eligible for tax deductions, annual returns over Rs. 1 lakh through ELSS are taxed at 10%. In other words, they are not tax-free.

  1. ELSS is a risk-free investment

The underlying assets of ELSS funds are equities and equity-related instruments. Hence, ELSS is not a risk-free investment. However, the risk could be minimized through diversification and efficient management of assets by reputed Asset Management Companies (AMCs).

  1. ELSS investments are for your short-term financial goals

ELSS has a minimum lock-in period of 3 years. Therefore, it is a medium- to long-term investment.

  1. ELSS is automatically redeemed after 3 years

ELSS is not redeemed automatically after the lock-in period. It gets converted into an open-ended equity fund, which is redeemable on demand.

  1. Investment in ELSS has to be in a single fund for tax benefits

You don’t have to put your entire investment in a single ELSS fund. Diversifying your ELSS investment in different funds will not affect your eligibility for tax deductions.

  1. You can’t invest in ELSS in small amounts

You can invest in ELSS with as low as Rs. 500 per month through a Systematic Investment Plan (SIP). However, the lock-in period is computed for each installment of the SIP as per the date of obtaining the amount. Therefore, the effective lock-in period may be more than 3 years.