They offer the twin
benefits of tax deduction &capital appreciation. Here are a few things you
should know before you invest in these tax-saving funds.
(1) How much is the
risk...?
Equity Linked Savings
Scheme (ELSS) funds are essentially diversified equity funds and carry the same
risks.
In fact, the risk is
higher in ELSS funds because you can not exit before 3 years.
However, the average
ELSS fund has performed better than the average diversified equity fund in the
past 5 years. While the ELLS category has given 15% annualised returns, the
diversified funds have given 14%.
This is partly
because a large number of equity diversified funds pull down the average
returns. However, not all ELSS funds have performed so well. While the best
performing ELSS fund has given 22% annualised return in the past 5 years, the
worst performer has given only 4%. So, choosing the right fund is crucial.
(2) What is the
taxability..?
ELSS funds fall under
the exemptexempt-exempt (EEE) category. Investments get tax deduction under
Income Tax Section 80 C, so you do not have to pay tax on the amount invested
in the ELSS fund.
The capital gains
generated by the fund are also exempt from tax as the investments are not
withdrawn. Finally, withdrawals are also tax-free because there is no tax
payable on long-term capital gains from equity-oriented mutual funds.
Since the holding
period necessarily exceeds one year, there is no capital gains tax. The
Employee Provident Fund and the Public Provident Fund are the only other
investment options that enjoy the EEE tax treatment.
(3) What is the
lock-in period..?
All tax-saving
investments have lock-in periods ranging from 3 to 15 years. ELSS funds have a
lock-in period of 3 years, the shortest among all Section 80 C investment
options. While this reduces liquidity and prevents the investor from making
changes, it can be a blessing in disguise. From 2014-15, maximum ELSS Tax
savings is Rs. 1.5 lakh.
It also means that
redemptions are not a worry for the fund manager and he can take long-term
investment decisions, which generally prove beneficial for the fund. For the
investors who take the SIP route, each monthly instalment is treated as a
separate investment and gets locked in for three years.
So, the SIP started
in July 2014 will be eligible for withdrawal in July 2017. Similarly, the SIP
invested in August 2014 will be open for withdrawal only in August 2017.
(4) Growth or /
dividend.. ?
You can opt for the
growth, dividend or dividend reinvestment plan. The growth plan is the
cumulative option under which your investment will keep growing till you redeem
it. In the dividend plan, the fund gives some amount back to if the fund's NAV
has risen.
The dividend received
by the investor are taxfree. Do not make the mistake of opting for the dividend
reinvestment plan, under which the dividend payout is reinvested to buy more
units of the scheme.
Everytime this
happens, the new units get locked in for another 3 years. So when you want to
exit, there will always be some units still locked in. If you are stuck in the
dividend reinvestment plan, you can write to the fund house and shift to the
dividend payout plan.
(5) What is the
threshold..?
Most equity funds
have a minimum investment limit of Rs. 5,000, but ELSS funds have a lower
threshold of Rs. 500.
Newbie investors who
want to test the waters before jumping in will find this especially useful.
These funds also offer a greater flexibility to investors. Unlike an insurance
plan or a unit-linked insurance plan (Ulip), you don't have to commit
multi-year investments. Even a one-time investment of Rs. 500 can be held till perpetuity. In the
PPF, the investor must make at least one contribution in a year or pay a
penalty.
However, there is no
such compulsion in ELSS funds.
Src: ET
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