Tax season 2024: How to make the most of your ELSS investment

ELSS funds are equity funds that invest a major portion of their corpus into equity or equity-related instruments. ELSS funds are also called tax saving schemes since they offer tax exemption of up to Rs 150,000 from your annual taxable income under Section 80C of the Income Tax Act under the old tax regime.

An ELSS fund is an equity-oriented scheme with a mandatory lock-in period of three years. In recent years, many taxpayers have turned to ELSS schemes to avail of tax benefits. 

If you invest in ELSS schemes, then you can avail tax exemption of the invested amount up to a limit of Rs 150,000. Further, the income that you earn under this scheme at the end of the three-year tenure will be considered as Long Term Capital Gain (LTCG) and will be taxed at 10% (if the income is above Rs 1 lakh).

Now that the tax season is here, Section 80C remains a popular tax-saving tool in the hands of the taxpayer for those who opt for the old tax regime and the ELSS is a popular choice. All tax-saving instruments under section 80C of the Income Tax Act have a certain number of years in lock-in. As compared to any of these options, ELSS has the shortest lock-in period and the potential for higher returns in the long term.

" If you invest Rs 1.5 lakh in an ELSS fund in the financial year and fall under the highest tax bracket ( Rs 10 lakh and above), you can save Rs 46,800 in taxes," said Value Research in a note. 

The way Section 80C tax deduction works is that your taxable income goes down to the extent of your investment amount, subject to a maximum of Rs 1.5 lakh. 

Why ELSS?

"ELSS schemes are mutual fund schemes that offer exposure to various underlying markets, such as large-cap, mid-cap, or flexicap. These schemes are recommended for tax-conscious individuals with a debt-heavy asset allocation. ELSS allows participants to participate in the equity market while saving tax. The mandatory lock-in period of 3 years prevents withdrawals. During market downturns, the long-term potential of equities can help overcome temporary fluctuations. The lock-in does not significantly impact the investment method, but the market's level of exposure should be considered. SIPs over 12 instalments across 12 months are recommended for ELSS investments," said Vijay Kuppa, CEO InCred Money.

Should you invest through SIP or lumpsum? 

" Opting for a Systematic Investment Plan (SIP) allows investors to automate their contributions at regular intervals, promoting discipline and harnessing the benefits of rupee-cost averaging. For investing in ELSS, one can either opt for a 1.5 lakh lumpsum or distribute Rs 1.5 lakh over the year in SIP instalments of Rs 12,500. The SIP strategy can be particularly advantageous in the volatile equity markets, as it spreads investments over time. On the other hand, a lump sum investment provides the advantage of immediate exposure to the market, potentially benefiting from market rallies. The choice between SIP and lump sum should align with the investor's risk tolerance, financial goals, and market outlook," said Misbah Baxamusa, CEO of NJ Wealth.

What about the lock-in? 

The lock-in period for ELSS funds lasts for three years from the date of your investment. To find out when it ends, simply add 3 years to the date you invested. If you invest through SIP, consider each instalment as a separate investment with its own lock-in period from the date of SIP registration itself. As such, each SIP instalment is considered as a separate lumpsum investment for purpose of lock-in period.

The lock-in period  provides you additional tax benefits on the return earned due to the lock-in. The question of short-term capital gains also gets eliminated, and you will only be paying long-term capital gains tax at 10% on the gains exceeding Rs. 1 lakh overall at the time of redemption. Tax-saving benefits are only available if you opt for the old tax regime. No tax benefit is available under the new tax regime for any investment instruments.

How to pick the right ELSS fund?

"Picking the right ELSS fund is similar to choosing any equity-oriented mutual fund. Pick the fund as per your objectives, risk tolerance and horizon to hold the investments for at least three years. Periodically evaluate your ELSS investments and make adjustments as needed based on your risk tolerance and changing financial goals. Avoid withdrawing your investment before the mandatory lock-in period of 3 years. Remain invested even during market downturns, as the long-term potential of equities can help overcome temporary fluctuations," said Baxamusa. 

Choosing the right fund is very important as the return gap between the top quartile and bottom quartile is huge.

"One may look at various factors including consistency in outperforming benchmark, Risk ratios, fund manager track record,  AUM Size etc to select a fund. Allocate the maximum possible amount allowed in the category for tax saving. Invest for the long term and don't hurry to redeem the fund after lock-in of 3 years is over. Review the fund performance after lock-in period is over and stay invested at least 5-10 years or even more if all parameters are okay. Invest regularly through SIP /STP and use any substantial downside in the market to add a lump sum," said Mukesh Kochar, national head, Wealth, AUM Capital.

There are two major mistakes an investor should avoid to get the maximum benefits of a tax-saving ELSS fund:

The first mistake is to approach this investment only as a tax-saving investment: Tax efficiency should be a subset of your goal planning. "The ideal way would be to identify your important financial goals and then, depending upon tax saving requirements, some of the investments can be channelized towards a tax saving fund. This would allow you to not only meet your long-term goals but additionally also give you taxation efficiency for the financial year," said Harsh Gahlaut, Co-founder & CEO, FinEdge.
 

The second mistake would be to wait for the last quarter of the financial year and to invest under pressure (usually when HR asks for tax saving proof). "This can be avoided by planning, staggering and automating your tax-saving investments at the beginning of the financial year. By identifying the amount, you can save under section 80 C at the beginning of the year, reviewing your financial plan and then aligning a monthly SIP in an ELSS would give you multiple benefits of investing towards your goals, saving taxes, reducing risk by staggering your investments as well as reducing the pressure on your finances of investing lump sum at the end of the year," said Gahlaut.