Lock-in period makes Equity Linked Saving Scheme less volatile

The month of April sets the ball rolling for new paycheck in terms of salary hike and bonuses and also assignments and responsibilities. It also gives the individual a full 12-month window to plan his/her forthcoming investments and taxes, and to undertake portfolio adjustments, if required.

For successful accomplishment of any assignment, planning takes the majority of energy and focus, while implementation is a lot simpler. The first pathway which for accomplishing it is the route of Equity Linked Saving Scheme (ELSS) of mutual funds. It is a tax-saving mutual fund scheme that predominantly invests in equity, thus providing scope for capital appreciation. It is the ideal product to create wealth over the long term, wherein every investment made also provides tax deduction, subject to specified limits.

Tax saving - The traditional saving products available under section 80C of the IT Act, 1961 are fixed income products such as PPF, FD, EPF, etc. ELSS is the only pure equity product which also qualifies for tax deductions, up to the overall limit of Rs 1.50 lakh under section 80C. This translates into a tax saving upward of Rs 20,000 for the year taking into consideration the money invested, individual tax slabs and the cess rates.

Equity route - While most of the investment products available under section 80C are pure debt or debt-oriented products, ELSS invests solely in equity funds through the mutual fund route which is safer, transparent, tax efficient and generates higher returns as well.

Lock-in period - Investments done in ELSS schemes have a lock-in period of three years. This means that investments done in, say, April 2019 cannot be redeemed before April 2022. Likewise, each Systematic Investment Plan (SIP) done in ELSS is treated as a separate investment and every instalment must be held for a three-year period before it can be redeemed. This is against the common investor perception of counting three-years from the date of the first SIP done in the scheme for all the subsequent SIPs.

The defined lock-in goes in favour of the investor as it makes the fund less vulnerable to volatility in cash flows. It also provides the investor higher liquidity as compared to other investment options available under section 80C such as PPF, FD, NPS etc.

Capital gains - Since ELSS investments are equity products, and they permit redemption only after three years, it qualifies for long-term capital gains tax on redemption. Such long-term capital gains, above the amount of Rs 1 lakh, are taxed at 10%. For the benefit of taxpayers, such gains till January 31, 2018 are grand-fathered and those made after January 31, 2018 will be taxed.

So, assuming someone has invested Rs 10 lakh over a period of five to six years in a few ELSS schemes, and he redeems Rs 12.50 lakh later on, the long-term capital gain works out to be Rs 2.50 lakh (Rs 12.50 lakh minus Rs 10 lakh), out of which the taxable portion is Rs 1.50 lakh only (Rs 2.50 lakh minus Rs 1 lakh) on which he will pay 10% tax (that is, Rs 15,000).

Thus, ELSS offers multiple advantages, most significantly that of potential capital appreciation and tax rebate at the same time. Investors can achieve their financial goals by creating an ELSS portfolio and getting tax rebates each year for fresh investments. Investments in a ELSS can be made as a lump sum or by SIP instalments, as low as Rs 500 per month, and then pumping in lump sums as and when excess funds are available.

The writer is a certified financial planner