They are mostly open-ended equity funds, meaning an investor can enter the fund at any time, that are classified as tax-saving instruments under Section 80C of the Income Tax Act. ELSS funds allow the taxpayer to save up to Rs1,50,000 on tax annually and are a better option for investors who are new to the market.
ELSS funds come with a lock-in period of three years, which is shorter than other tax-free investments. However, this lock-in period helps investors secure their savings.
An investor can start investing in ELSS funds with a minimum amount of Rs500 and there is no upper limit to this.
ELSS funds come with two options:
The Growth Option
This route is suited for investors looking for long-term wealth creation. In this option, the investor may choose to receive an accumulated amount of investment and profits at the end of the lock-in period or choose to reinvest the same.
The Dividend Option
In this route, the investor gets tax-free dividend payouts during the investment period. The dividend options are further divided into two categories: dividend reinvestment and dividend payout. Dividend payout option allows the investor to receive tax-free dividends. This ensures regular income from investment. On the contrary, in the dividend reinvestment option, the investor’s dividend is reinvested as a fresh investment, but the benefits of tax deduction still apply.
How to invest in ELSS funds
An investor can either make a lump sum investment or they can opt for a Systematic Investment Plan (SIP) to begin investing in ELSS funds. Through SIP, the investor contributes a predecided monthly amount at fixed intervals to the fund. However, investors should note that in this investment method, each SIP is treated as a fresh (separate) investment and hence, the standard three-year lock-in period applies to each SIP individually.
A SIP for ELSS mutual funds can be started with a minimum amount of Rs500.
Benefits of the SIP route
When investing through the SIP method, an investor gets the following benefits:
- Investing discipline is instilled
- There is no "right time" for investment when opting for this method
- The investor gets the benefit of Rupee cost averaging, i.e. he/she gets more units when the market is low or gets fewer units when it is high
- The investor can invest as per his/her convenience
In the budget for the fiscal year 2018-19, the Government introduced a Long-Tem Capital Gains Tax (LTCG) provision on all equity funds. This included ELSS funds too. Consequently, the LTCG tax for ELSS funds held over one year is 10% for gains over Rs1lakh without indexation. Income distributed through these mutual funds also invites 10% LTCG tax. Moreover, ELSS funds are now also subject to 18% GST, as they fall in the category of financial services.