Best ELSS Funds

ELSS funds bring some unique benefits along with it. Tax exemption under Section 80C is the most obvious of them. But there are quite a few more critical benefits that you need to be aware of.

• ELSS funds are equity funds and hence are useful as long term wealth creators. They may be volatile in the short term but like most equity funds then tend to create wealth over the long term.
• The 3 year lock in period on ELSS puts a discipline in the investors. Equity funds are liquid from day 1 and so there is a tendency to book profits in a bull market or panic and exit in a bear market. The compulsory lock-in period of 3 years forces investors to take a long term view
• Fund managers are able to take a long term view as they need not worry about keep liquidity available like in case of equity funds. Since redemptions are limited in case of ELSS funds, it enables fund managers to take a longer term view which works in favour of the investors in terms of long term returns.
• One can structure ELSS also as SIPs. This not only synchronizes the ELSS outflows with the income flows but also gives an added advantage of rupee cost averaging (RCA). Over a period of time, this enables the fund investor to reduce the cost of acquisition and thus enhance the yield on investments.
• Compared to other tax saving instruments under Section 80C, the ELSS funds have the lowest lock in period of 3 years. Comparatively, the long term FDs are locked in for five years while PPF and ULIPs are locked in for atleast 5 to 7 years.

When it comes to Section 80C, ELSS is just one of the options available to you. There are other options like PPF, contributory PF, life insurance premium, ULIPs, long term bank FDs, tuition fee payments, home loan principal etc. While one must be driven by the overall asset allocation in deciding the extent of ELSS exposure, the ELSS option has some distinct advantages over the other options. Here are some of the key advantages in opting for an ELSS for your Section 80C.

1. ELSS funds combine the twin benefits of wealth creation and tax exemption. If you look at other asset classes like PPF, long term FDs, post office long term FDs then none of these are wealth creators. Only ELSS is an equity driven long term wealth creator.
2. ELSS lock in is much lower than other classes of tax saving instruments. For example, the PPF has a lock in period of atleast 7 years while the long term bank FDs and ULIPs have a lock in period of 5 years. Also, products like ULIPs have huge loading in the initial years and that takes them longer to break even.
3. ELSS can give you the benefit of rupee cost averaging. Even if you contribute to your PPF or long term bank FDs on a regular basis, there is no unique advantage that you get. In the case of ELSS, if you adopt a SIP approach then your cost acquisition comes down and that enhances your return on investment.
4. There are no upper limits on investing in ELSS. For example, investments in PPF and long term bank FDs in any year are subject to upper limits. There is not such upper limit in case of ELSS funds and the limit can be extended much more than you may require. It is a different matter if you should invest or not!
5. ELSS done through SIPs gel better into the financial plan of an individual. This ensures that your tax planning syncs appropriately as a subset of your overall financial plan.

An ELSS offers some unique advantages like shorter lock-in period, better wealth creation and a better fit to long term financial goals.

An investor looking to save tax via ELSS funds can allocate funds in a variety of ways. If you have a lump sum amount with you, then you can invest in bulk or you can also go to your AMC and register a systematic investment plan (SIP) on the ELSS fund. The 3-year lock in period for these SIPs will kick in from the date of the SIP investment. However, given a choice, it is recommended to adopt a SIP approach to investing in ELSS funds. Here is why…

• By adopting an SIP approach, you are able to better synchronize your outflows and your inflows. Your tax saving activity becomes more organized and you do not have to rush around for arranging funds at the end of the year.
• An SIP approach gives you the benefit of rupee cost averaging. That means when NAVs go higher you get more value and when NAVs come down you get more units. This formula is very useful in volatile markets as it enables you to bring down your cost of acquisition and improve your ROI.
• A SIP approach to ELSS investing enables you to better manage the liquidity of your ELSS investments. Since the ELSS has a mandatory 3 year lock in period, the SIP ensures that in the third year, each month the SIP equivalent gets freed up. This helps in better liquidity management.
• Tax liability for the full year can be hard to judge as you may get increments during the year. In that case, your tax liability for the full year could go up drastically. That means a lump-sum investor will be in for a shock. However, a SIP approach will be more flexible in such cases.

That is actually a very good idea. Why do we invest in mutual funds? The reason is to get the benefit of diversified risk management and higher comparable returns over a period of time. As a first time investor, you may not have the expertise to invest in direct equities. Hence mutual funds may be the right way to start. Even within mutual funds, equity funds may be the right choice as they combine the ability to generate returns in the long run. But what will be your trigger for investing in equity funds? One such trigger can be tax planning.

When we start earning income, we are authorized and obligated to save our taxes. ELSS funds offer tax exemption under Section 80C of the Income Tax Act to the extent of an outer limit of Rs1.50 lakhs per annum. Here you can hit two birds with one stone. Use ELSS funds as your entry point to get into equity funds. The compulsory lock in of 3 years will keep you away from the temptation of exiting your equity fund early. At the same time, once you see the returns on an equity fund, you will have greater conviction to invest in equity funds at a later stage and use that for financial planning.

ELSS funds also have some distinct advantages over other classes of instruments that are eligible for Section 80C. For example, ELSS is the only instrument among Section 80C instruments that is a long term wealth creator. It fits in ideally when you are young and your risk appetite and risk capacity are quite high. Also, you need to create wealth in the long term and the earlier you start the better it is. Also, the lock in period is just 3 years and so you can churn your money more efficiently. That is surely a good starting point for investors.

One needs to understand that earnings from ELSS funds are defined in a variety of ways. There is dividend income, there are short term gains and then there are long term gains. Of course, short term gains are not applicable to ELSS since these funds have a mandatory lock in period of 3 years and any holding in equity funds of more than 1 year is necessarily classified as LTCG. So, let us look at dividends, capital gains and redemption reinvestments and the tax implications.

• It is quite common to opt for dividend plans of ELSS as it helps to monetize part of the fund during the lock in period. However, from the point of view of long term wealth creation, dividends are not a great idea. How are dividends on ELSS funds taxed? Dividends are tax free in the hands of the investor. However, dividends declared by equity funds are subject to Dividend Distribution Tax (DDT) at the rate of 10% plus surcharge and cess, which takes the effective rate to 11.648%. To that extent, your net returns are impacted.
• What about LTCG on ELSS funds. In case of equity funds, the definition of LTCG is a holding period of more than 1 year. Since ELSS funds are subject to a mandatory lock in period of 3 years, then are by default LTCG. Any gains on ELSS funds are exempt up to Rs1 lakh in any financial year. Any gain beyond that will be taxed at a flat rate of 10% without any indexation benefits. This is effective from April 2018.
• Losses on ELSS funds can be booked and either adjusted against other capital gains or can be carried forward for a period of 8 assessment years. At the end of 3 years, the redemption proceeds can again be invested in the ELSS fund and the benefit of Section 80C can once again be claimed in that particular year by rolling old funds.

The advantage of an ELSS fund is that the lock in period is the lowest among the tax saving instruments under Section 80C of the Income Tax Act. An ELSS fund has a mandatory lock in period of 3 years from the date of investment. That means, if the SIP approach is adopted for an ELSS , then the lock in will commence from the date of the SIP for each installment and the lock in will be removed exactly 3 years after that. In comparison, long term bank FDs has a lock in period of 5 years while PPF has a lock in of 7 years. Effectively, by the time you can churn your PPF money twice you can churn the ELSS money five times leading to substantially levels of tax breaks. Normally, equity funds have an exit load for exiting before 1 year. However, since the ELSS funds have a mandatory lock in of 3 years, they are normally not subject to any exit load.