Equity Linked Savings Scheme gives you tax benefits up to Rs 1.50 lakh and excellent opportunity for capital appreciation in the long term
My friend's son who has recently taken up his first job called me to ask which is the best tax-efficient investment products to accumulate funds for 10 years.
This question triggered my thought process, and I started evaluating various options available for youngsters like him, who wish to accumulate a fund for the long term and to save tax as well.
The first thing which came to my mind was ELSS (Equity Linked Savings Scheme) which entitles you to avail tax benefits under Section 80 C up to Rs 1.50 lakh besides offering an excellent opportunity for capital appreciation in the long term. Let us discuss in detail.
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- If you start investing Rs 1,00,000 in a good ELSS every year, during the entire 35 years of your employment tenure and presuming it generates the returns as the historical return of 16%, you will be able to accumulate a whopping amount of Rs 13 crore at the time of your retirement
- It is presumed that you start your career at the age of 25, and retire at 60 years after having put in 35 years of service
- The above calculation is done without taking account, the amount of income tax, which you would be able to save by contributing to ELSS
- At present, long-term capital gains on equity-oriented schemes like ELSS are tax-free up to Rs 1 lakh every year and beyond which it is taxed at a flat rate of 10%.
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So how big would be this sum?
The average returns generated by Sensex over a period of 40 years between 1979, its base year, to present 2019 are approximately 16%. These returns have successfully overcome various aberrations caused due to scams like the ones perpetrated by Harshad Mehta and Ketan Parekh. It has also been able to absorb and iron out the turmoil caused from time to time due to various crises like subprime, oil and other country-specific ones. The return calculated above does not take into account the dividends Sensex companies have given over the above period. As of today, the yield on Sensex scrip is around 1.21%.
One product which allows you to save tax and reap the benefits of equity return is ELSS.
So presuming you start investing Rs 1,00,000 in a good ELSS every year, during the entire 35 years of your employment tenure and presuming it generates the returns as the historical return of 16%, you will be able to accumulate a whopping amount of Rs 13 crore at the time of your retirement. It is presumed that you start your career at the age of 25, and retire at 60 years after having put in 35 years of service. The above calculation is done without taking account, the amount of income tax, which you would be able to save by contributing to ELSS.
At present, long-term capital gains on equity-oriented schemes like ELSS are tax-free up to Rs 1 lakh every year and beyond which it is taxed at a flat rate of 10%. The tax rates and provisions keep on changing. It is not possible to predict the tax regime for taxation of ELSS which is likely to be prevalent at the time of your retirement. I have ignored the taxation aspect while arriving at the corpus numbers. Had the tax of 10% been taken into account, the net corpus would come down to Rs 11.70 crore.
Let me add that there is no entry load on the purchase of units of mutual funds and also there is no transaction cost involved in investing in ELSS at present. However, it is pertinent to note that the asset management companies charge fund management charges, which average around 1.50% of the asset under management. Since we have not taken into account the dividend yield of Sensex listed companies, I think the dividend yield will take care of fund management charges for our calculation arrived above.
How to go about it
For investing in any equity-linked product, ELSS is an equity-linked product, investing lumpsum at a go it not advisable as the equity market is very volatile. So you should stagger your investment and invest in the ELSS through Systematic Investment Plan every month so that the effect of the volatility is minimised. Investing through will also help you to get the benefit of rupee cost averaging.
Lock-in period for investments made in ELSS
The investments made by you in ELSS have a lock-in period of three years so you cannot redeem your ELSS investments for three years. In case you have invested in ELSS through SIP each investment of SIP will be treated as separate investments and each SIP has to complete a period of three years.
Since long-term capital gains on ELSS are tax-free up to Rs 1 lakh every year, you should redeem your investment in ELSS up to the amount of investments that gets you benefit of 1 lakh tax-free long term capital gains.
Since there are no major transaction costs in ELSS, you can recycle your existing investments which have completed the lock-in period of three years to avail the benefit of 80C deduction without actually sparing any money in case you are facing a liquidity crisis. This will ensure that you are able to avail the benefit of tax-free income of Rs 1 lakh and also avail the tax benefits without investing any money.
So log on to the websites of mutual Funds whose ELSS has performed reasonably well consistently in the past and start contributing.
The writer is a tax and investment expert
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