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Tuesday, June 15, 2010

Mutual Fund ELSS - Best Tax Saving Instrument

Equity Linked Savings Scheme (ELSS) is a mutual fund savings scheme that predominantly invests in equity and offers tax deduction to investors under section 80C of Income Tax Act. It has a lock-in period of 3 years.

What is section 80C?

As per Income Tax act 80c investment up to Rs 1,00,000 in tax saving instruments like PPF, NSC, ELSS etc. are eligible for deduction from the gross total income hence reducing the total taxable income.

For example, Mr. Suresh (Resident individual with age less than 65 years) has annual income of Rs 10,00,000 and he invest Rs 1,00,000 in ELSS then his taxable income is reduced to Rs 9,00,000. As per the current tax laws, his saving will be Rs. 30000 if he takes benefit of section 80C provision.

Benefits of ELSS over other Tax Saving Instruments

High Risk- High Return: ELSS being a equity-linked scheme has the potential to earn higher returns as compared to other tax-saving instruments that give returns of a fixed nature. A longer investment horizon reduces the risk in equity investment considerably. Lock-in-period of 3 years in ELSS ensures that investor has a longer investment horizon. Moreover, an investor has the option to stay invested for more than 3 years.

Liquidity: On liquidity parameter, ELSS is the best option. The lock-in period of 3 years is the shortest as compared to other tax saving instruments. The maturity period of NSC is 6 years and of PPF is 15 years. An investor looking for intermittent cash flow can also opt for dividend payout option in ELSS.

According to current tax laws, dividend and long-term capital gains from ELSS schemes are tax-free in the hands of the investor under section 10(35) and section 10(38) respectively. Barring PPF, interest on all other tax saving instrument is taxable.

Investors can also go in for Systematic Investment Plan (SIP) in ELSS and benefit from the concept of rupee cost averaging and power of compounding.

Suitability: ELSS is suitable for all types of investors who have moderate to high risk appetite and need to invest in tax planning schemes/instruments.

Note: ELSS as tax saving instrument may not be the best option for an investor at the age of 55, if stock market is in bearish phase during that period, returns on investment from ELSS after 3 years may not exist and there could be loss, hence it is always good to invest through SIP (systematic Investment Plan).

ELSS is the best tax saving instrument for investors in the age group of 25 - 45, as they can hold it for a longer period to get good returns as compared to other tax saving instruments under 80C and keep on investing on regular basis to get benefitted from Rupee Cost averaging in a long run.