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Things to know about ELSS Mutual Funds
They offer the twin benefits of tax deduction and capital appreciation. Here are a few things you should know before you invest in these tax saving funds
How much is the risk?
ELSS funds are essentially diversified equity funds and carry the same risks. In fact, the risk is higher in ELSS funds because you cannot exit before three years.
However, the average ELSS fund has performed better than the average diversified equity fund in the past five years. While the ELLS category has given 15.2% annualised returns, the diversified funds have given 14.3%. 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 21.7% annualised return in the past five years, the worst performer has given only 3.8%. So, choosing the right fund is crucial.
What is the taxability?
ELSS funds fall under the exempt exempt exempt (EEE) category. Investments get tax deduction under Section 80C, so you don't 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 The capital gains generated by the fund are also exempt from tax as the investments are not withdrawn.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.
What is the lock-in period?
All tax-saving investments have lock-in periods ranging from three to 15 years.
ELSS funds have a lock-in period of three years, the shortest among all Section 80C investment options. While this reduces liquidity and prevents the investor from making changes, it can be a blessing in disguise. 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.
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 tax-free.
Don't make the mistake of opting for the dividend reinvestment plan, under which the dividend payout is reinvested to buy more units of the scheme.
Every time this happens, the new units get locked in for another three 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 pay out plan.
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.
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