How are ELSS Mutual Funds Taxed?

Gone are the days when taxpayers had no choice but to invest in tax saving schemes that are conservative in nature. Not only did they offer low interest rates, but such tax saving instruments also came with a predetermined lock in period which hampered the investor’s portfolio liquidity. However, thanks to ELSS now investors can not only bring down their tax liability, but they can also expect decent capital appreciation over the long term. Tax planning is a crucial aspect of financial planning and investors should make sure that they adequately invest in tax saving instruments depending on their appetite for risk. While making a list of long term financial goals, saving tax should top the list. Why should you give your hard earned money to the government when you can invest a portion of your monthly in a tax saving instrument and claim tax deductions for the same?

If you are keen on saving taxes and at the same time want to earn capital appreciation over the long run, then you can consider investing in ELSS. Equity Linked Savings Scheme or ELSS is a tax saving instrument that comes with a predetermined lock in period of three years. This means that you cannot redeem or withdraw your ELSS fund units for a minimum period of 36 months from the date of investment. Having said that, the three year lock in probably the shortest among other tax savings schemes. 

Choose from growth and dividend plan

Those seeking capital apperception and tax benefit through ELSS investments have the option of either going with the growth plan or dividend plan. If generating regular income is something on your mind, then you can choose the dividend plan. The dividends are distributed in the form of bonuses only if the scheme manages to make profit. The fund manager may withhold the dividends of the investors in case the ELSS fund has been consistently underperforming. On the other hand, a growth plan might work in favour of those individuals who seek long term capital gains through ELSS investments. In the growth plan, the capital appreciation earned by the scheme in invested back in the ELSS fund. Over a long time period, these periodic reinvestments might multiply due to compounding and turn into a large corpus.  

SIP for long term investment

If you want to inculcate the discipline of regular investing, then you need to opt for a SIP in ELSS fund. Systematic Investment Plan, abbreviated as SIP, is a convenient and hassle free way to invest in mutual funds. The best way to make the most out of ELSS investments is by starting a SIP. SIP allows systematic investments at periodic intervals through with you can gradually build a corpus to achieve your life’s long term financial goal. You can even use a SIP calculator to determine how much money you need to invest at regular intervals in order to achieve these goals. 

Taxation on ELSS funds

Long Term Capital Gains (LTCG) tax is now applicable for investors with who earn more than Rs. 1 lakh through their ELSS fund investments. Gains below Rs. 1 lakh are exempted from tax deductions. A tax of 10 percent is applicable for gains over Rs. 1 lakh. Dividends from ELSS are eligible for dividend distribution tax (DDT). Historically, ELSS has churned out highest post-tax returns as compared to traditional tax saving instruments. Since ELSS comes with a three year lock in period, there is no Short Term Capital Gains (tax) applicable here.

If you want to make sure that the tax deductions don’t affect your ELSS capital gains, then it is better to have a long term investment horizon.