ELSS (equity linked saving scheme) is a popular financial mutual fund option that clubs the potential of tax-saving benefits and wealth creation. This financial avenue primarily invests the investible in equity and equity-linked instruments, offering retail investors the opportunity to take part in the growth of stock market while offering tax benefits as per Section 80 C. Such funds come with a lock-in of just three years, making them one of the attractive tax-saving instruments for investors. 

Significance and benefits of ELSS – 

ELSS funds hold immense significance due to their dual benefits of tax savings and wealth creation potential. Here are some key advantages associated with ELSS – 

Capital appreciation

ELSS funds primarily invest in equities, aiming for long-term capital appreciation. By investing in quality stocks, these funds have the potential to generate higher returns compared to other traditional tax-saving options like fixed deposits (FDs) or public provident fund (PPF).

Tax deduction

As mentioned above, investments in ELSS qualify for tax deduction of up to Rs 1.50 lakh as per Section 80 C. This lowers the investor’s taxable income, resulting in reduced tax liability. 

Systematic investment option

ELSS funds allow investors to invest through the Systematic Investment Plan (SIP) route. This enables them to invest smaller amounts regularly, helping inculcate discipline and benefit from rupee cost averaging.

Lowest lock-in period

ELSS funds have the shortest lock-in period among the various investment options under Section 80C. With just a three-year lock-in, investors have the flexibility to access their funds relatively sooner compared to other tax-saving avenues like national savings certificates (NSC) or tax-saving FDs.

How ELSS helps lower tax burden and what is tax harvesting method?

ELSS funds not only provide tax deductions but also help in reducing the tax burden in the long run. One such method is tax harvesting. When the long-term capital gains from ELSS funds exceed Rs 1 lakh, investors can use this strategy to save tax.

The process of tax harvesting involves liquidating the units of an ELSS scheme that have generated long-term capital gains exceeding Rs 1 lakh. The gains above this threshold are subject to a 10% tax. However, instead of paying the tax, investors can reinvest the same amount in another ELSS scheme. This reinvestment resets the acquisition cost of the units and defers the tax liability until redemption.

Let’s consider an example to illustrate this – 

X invested Rs 2 lakh in an ELSS fund three years ago. Post the completion of three years lock-in period, his investment increases to Rs 3 lakh. On redemption, his long-term capital gains will be Rs 1 lakh i.e., Rs 3 lakh – Rs 2 lakh. 

To save tax using the tax harvesting method, X can liquidate the units generating the long-term capital gain of Rs 1 lakh and reinvest the same amount in another ELSS scheme within the same financial year. By doing so, he will not have to pay any tax on this gain. 

Benefits of tax harvesting in ELSS

Increased wealth creation

By saving on taxes, investors can reinvest the saved amount, which can lead to higher wealth creation over the long term.

Compounding growth

By reinvesting the capital gains in another ELSS scheme, investors can continue to benefit from compounding growth on the additional investment, potentially boosting their overall returns.

Tax deferral

Tax harvesting allows investors to defer the tax liability until the time of redemption, thereby providing potential savings on taxes over the years.

Conclusion

ELSS funds provide an excellent investment avenue for retail investors to save taxes and generate wealth. With the lowest lock-in period among the other 80C tax-saving options, ELSS funds offer flexibility and liquidity. Moreover, the tax harvesting method allows investors to optimise their tax savings by deferring tax liabilities and potentially benefiting from compounding growth. By considering ELSS funds, investors may not just reduce their tax burden but also achieve their life goals with the potential for generating higher returns.