One day, Akansha and her dad were sitting together, talking to their family financial planner. Her dad and financial planner were discussing about investing in Equity Linked Savings Scheme (ELSS).
Akansha was in 11th standard and did not know much about investing or various tax saving schemes. She asked her dad more about Equity Linked Savings Scheme. Her dad told her that, once she starts earning, every year she has to pay income tax.
Taxis a fee imposed by the government on an individual or an entity. So that, it can be used to fund various activities supported by the government like public infrastructure and social welfare schemes etc.
Income Tax is a tax imposed on a person’s income which can be their salaries, business, property and other sources like lotteries etc.
Akansha’s dad further said, that the government also provides various tax saving schemes like Public Provident Fund (PPF), Equity Linked Savings Scheme (ELSS). So that, people can pay less tax instead invest that money in something that gives them returns or secures their future.
Her dad said, the Equity Linked Savings Scheme is a type of mutual fund as well that can help you in saving income tax.
Now Akansha had a brief idea about the Equity Linked Savings Scheme (ELSS). However, there are more points that can help her understand meaning of ELSS in a much better way. Let us learn more about Equity Linked Savings Scheme.
What is the meaning of Mutual Funds ?
For us to understand an equity linked savings scheme. First we need to know the meaning of mutual funds. Lets assume that you and all your classmates have saved your pocket money. One of your classmates said, he heard from his dad that if they invest their savings in the stock market, Then after some time their money will double! All of you like the idea of doubling your money in long term. This means that you want to invest your money for long term wealth creation.
You all decided to invest your money, and luckily all of you have same objective for investing i.e. long term wealth creation. Some other classmate tells everyone that he knows a person who is expert in investing other people’s money for long term wealth creation.
Now, the entire class combined it and given to expert broker, he starts investing it by buying shares of different companies. This combined pool of funds is invested together, based on their common objective.
In India, you will find different types of mutual funds with different objectives. Some of these objectives can be to save taxes, to invest in big companies, to find alternative investment avenues.
What is Equity Linked Savings Scheme?
Equity Linked Savings Scheme is a type of Mutual Fund. Here, the word equity means, the shares an investor holds in a company. So, by investing in equity, investor becomes a partial owner in the company.
Like we discussed above, mutual funds are of various types, depending on the objective of investor. So, if one of the investors’ objectives is to save tax on their income, then the Equity Linked Savings Scheme is an option for investor.
Equity Linked Savings Scheme is a type of mutual fund that is mostly invested in equity, i.e.
, shares of different companies. If someone wants to save taxes charged on their income, then ELSS is an option provided by government under Section 80C of the Income Tax Act.
Features Of Equity Linked Savings Scheme
Lets discuss a few features of Equity Linked Savings Scheme (ELSS). Some of these features are most ELSS funds are invested in equity, they are tax saving options. ELSS have the lowest lock-in period, they are invested in a diversified manner and there are two options of investing in ELSS which are dividend payouts and dividend reinvestment.
- In Equity Linked Savings Scheme, more than 65% of the fund is invested in equity.
- Equity Linked Savings Scheme is a tax saving option according to Section 80C of the Income Tax Act of 1961.
- In India, we have different tax saving options in the market like National Pension Scheme, Unit Linked Investment Plan but these products have a lock-in period of more than 5 years or so. Lock-in period means when an investor cannot take back or sell his investment, it has to be kept locked-in so that investors can get the benefits of investing their money.
However, in Equity Linked Savings Scheme (ELSS), the lock-in period is of only 3 years. So, one can get tax saving benefits with a lock-in period of just 3 years, making ELSS a scheme with the lowest lock-in period.
- Funds are invested in a diversified manner in the equity market.
- There are two options in ELSS funds, Growth Option and Dividend Option.
If investors’ objective is long term wealth creation, then they can choose the Growth Option. In this option, the investor can choose to grow their money till the lock-in period and receive the accumulated money together.
If the investor wants to receive regular income from his investment, then they can choose the Dividend Option. Dividend means when a company where the investor has shares regularly pays its investors a sum of money from their profits. Dividend option is further divided into dividend payouts and dividend reinvestment.
In Dividend Payouts, the investor can get regular income by receiving tax-free dividends. In Dividend Re- investments, the dividends of investor are re-invested in fresh investments, which are tax-saving as well.
Investment Method of Equity Linked Savings Scheme (ELSS)
Before investing in an Equity Linked Savings Scheme(ELSS), one must be clear about their financial goals, risk appetite, and schemes’ performance in the last few years.
Since ELSS invests in equity, there are chances of risks involved as returns received by an investor depends on the market. Hence, if aim of an investor is just to save taxes, then they should look for other tax saving options in the market.
There are two methods of investment when it comes to Equity Linked Savings Scheme (ELSS). They are lump sum investments or systematic investment plans (SIP).
In lump sum investment, the entire money is invested in one go. In a Systematic Investment Plan (SIP) one can invest a specified sum of money at regular intervals. Every time an investor invests through SIP, it is treated as a fresh investment. So, every fresh investment will have a lock-in period of three years.
Equity Linked Savings Scheme and Systematic Investment Plan
Investors can invest in Mutual Funds in many ways. Some of these ways includes lump sum investment, systematic investment plan, systematic transfer plan, dividend transfer plan, and systematic withdrawal plan.
So, Systematic Investment Plan is a way of investment. It is a way of investment, not just Equity Linked Savings Scheme, but Mutual Funds in general. Whereas Equity Linked Savings Scheme is an investment vehicle itself. It is a Mutual Fund Scheme.
Hence, we can conclude that Equity Linked Savings Scheme (ELSS) and Systematic Investment Plan (SIP) do not mean the same thing. ELSS is a Mutual Fund Scheme and SIP is a method of investing in a Mutual Fund.
Advantages and Disadvantages of Equity Linked Savings Scheme
Now that we have discussed the major features and method of investing in Equity Linked Savings Scheme. Lets discuss the advantages and disadvantages of equity linked savings schemes.
Some advantages of ELSS are ,they are a tax saving option, professionally managed, they have lowest lock-in period. ELSS provides better returns, and they also provide flexibility in regard to their investment method.
Some disadvantages of ELSS are, they are risky investments, they are taxed after their maturity date, there are no guaranteed returns, there is market volatility that can affect ELSS, you cannot withdraw your investment before time.
Advantages of Equity Linked Savings Scheme are
- Equity Linked Savings Scheme is a tax saving option that provides a tax deduction upto Rs 1.5 lakh.
- ELSS is professionally managed by a fund manager. Even if an investor does not have much knowledge about investment, it can be a good tax saving option.
- Equity Linked Savings Scheme has the lowest lock-in period of just three years, among all the other tax saving options like National Pension Scheme, Public Provident Fund Scheme, etc.
- ELSS provides flexibility to invest either through lump sum method or systematic investment plan method (SIP).
- After the lock-in period is over, the investor can withdraw the entire sum of money. Equity Linked Savings Scheme also provides better returns than other tax saving options.
Disadvantages of Equity Linked Savings Scheme are:
- If risk appetite of an investor is low, then Equity Linked Savings Scheme should not be taken by an investor, as the scheme invests mostly in equity markets. Equity markets carry some amount of risk.
- After the lock-in period is over, an investor receives his investment back. This money is taxable and will be treated as your capital gains. It will be taxed under Long Term Capital Gains Tax.
- At the end of the day, Equity Linked Savings Scheme is a mutual fund. There is no guarantee returns on investments in mutual funds.
- Equity Linked Savings Scheme has a lock in period of only 3 years. Many investors find this option attractive because of its low lock-in period. However, equity markets are volatile and investment plans for ELSS should be long term.
- Bank deposits and Public Provident Funds allows you to withdraw your money before time under certain situations. However, with ELSS you cannot withdraw your money before the maturity date.
Equity Linked Savings Scheme is a popular option among young investors who want to save taxes on their income. It is a type of mutual fund that invests more than 65% in equity market.
It has the lowest lock-in period of just three years when compared to its competitors. There are two methods of investing in Equity Linked Savings Scheme, they are Systematic Investment Plan and Lump sum Investment Plan. However, one has to be careful before investing in ELSS as it invests heavily in the equity market and equity markets are known to be volatile.
ELSS is better suited for an investor with a good risk appetite and has objective of long term wealth creation.
FAQs about ELSS Scheme
Equity Linked Savings Scheme is a type of mutual fund that invests more than 65% in equity market. It is a popular tax saving scheme with lowest lock-in period of three years.
Though ELSS are proven to give good returns, if the risk appetite of an investor is low then the Equity Linked Savings Scheme should not be taken by an investor. This scheme invests mostly in equity markets. Equity markets carry some amount of risk and are subject to market volatility.
Yes, Equity Linked Savings Scheme is an open-ended scheme. An open-ended scheme means that an investor can subscribe to fund at any time, and it is directly sold by a fund company to an investor.On the other hand, a close funded scheme can be purchased only during the initial public offering of the company.
Yes, Equity Linked Savings Scheme is good for retirement. Retirement plans are long term commitments. Though ELSS is subject to market volatility because it invests in equity shares, markets stabilize in the long run and give good returns. ELSS is a good option for investors with long term wealth creation objectives.
No, Equity Linked Savings Scheme and Systematic Investment Plan are not same. ELSS is a Mutual Fund Scheme and SIP is a method of investing in a Mutual Fund.
There are two methods of investment when it comes to Equity Linked Savings Scheme (ELSS). They are lump sum investments or systematic investment plans (SIP).In lump sum investment, the entire money is invested in one go. In a Systematic Investment Plan (SIP) one can invest a specified sum of money at regular intervals.
Equity Linked Savings Scheme was introduced in 2005.
An investor can claim tax deductions up to Rupees 1.5 Lakhs under Section 80C of the Income Tax Act 1961.
Yes, ELSS is taxable after three years as it is treated as capital gains and is taxed under Long Term Capital Gains Tax.
Anagha has completed her B. A. in Economics and is currently a final year post-graduate student enrolled in an M.A Economics program at A.V College of Arts, Science, and Commerce which is affiliated with Mumbai University. Her final year research project is on the ‘Gendered Effects of Covid-19’ where she looks at the impact of Covid-19 on the job market for women and the increasing gender gap in the employment landscape of India.