Equity Linked Saving Schemes(ELSS)

Tax planning is an essential part of the financial planning process. Efficient tax planning enables you to reduce your tax liability to the minimum. This is done by legitimately taking advantage of all tax exemptions, deductions rebate and allowances while ensuring that your investments are in line with your long term goals. Equity Linked Saving Scheme is one such instrument which allows you do this. Equity Linked Saving Scheme (ELSS) is a type of equity mutual fund that invests major portion of its corpus into equity and equity related instruments. It is an equity diversified scheme that invests across stocks and sectors. In terms of its structure and where it puts its money in, it is very similar to any other plain vanilla equity diversified equity scheme. The only difference is that ELSS offers tax deduction benefits up to Rs 1 lakh under section 80C. So if you invest Rs 1 lakh in an ELSS, you save Rs30900 (30.90% tax; if you're in the highest tax bracket). The only price that you pay for saving tax is that your money gets locked in for three years. After three years, you are free to exit or stay invested and enjoy equity returns over a long period of time. Let's try and understand the returns on an ELSS with an example: Let's assume you invest Rs. 1 lakh this year in an ELSS scheme and you are in the highest tax bracket. Invested Amount = Rs. 100,000/- Income Tax saved = Rs. 30,000 (30% tax slab) Net amount Invested = Rs. 70,000/- ( 30,000 is deducted because you get it back up front after your investment as income tax benefit and you effectively invested only Rs. 70,000) Let us assume your equity investment grows at the rate of 15% per annum. Investment value at the end of the First year = 115,000/- Investment value at the end of the Second year = 132,250/- Investment value at the end of the Third year = 152,087/- Assuming you en cashed your investment at the end of the 3rd year you will get Rs. 152,087/- Profit you realized = Rs. 82,087/- (You invested only Rs. 70000 effectively) Profit percentage = 117% (For 3 years together) Returns % per year = 39% Returns of 39% per annum are something you cannot expect in any other form of investment.

Thus ELSS schemes make one of the best investment options. However this totally depends on how the whole Share Market Watch is behaving. What is the asset allocation in such schemes? The asset allocation is pre-determined and is in accordance with SEBI guidelines. 80% to 100% is invested in equities, cumulative convertible preference shares and fully convertible debentures and bonds of companies. Money market instruments account for anything between 0% to 20%. The asset allocation shows a tilt towards equities which has the scope for providing good returns for investors. The choice of industries and allocation to mid-cap and large-cap companies depends on the individual scheme & its fund manager. As an investor, you must first understand the objectives of the fund and also go through the offer document before investing. Difference between ELSS Plans and Other Mutual Funds There are 2 major features that make ELSS plans different from other mutual funds:

1. Income Tax Benefit: Investments made in ELSS plans are eligible for deduction from the taxable income under Section 80C of the Income Tax Act. There is no limit for investments in ELSS plans, but investments of up to Rs 100,000 qualify for income tax benefits. Investments made in normal mutual funds (other than ELSS plans) do not qualify for income tax deduction.

2. 3 Year Lock-in Period: Investments made in ELSS plans have a lock-in period of 3 years. In case of normal mutual funds this lock-in period is not there. In an ELSS plan every installment has a lock-in period of 3 years.

Features of an ELSS Plan

ELSS is an equity linked tax saving investment instrument. Money collected under ELSS plan is mainly invested in equity and equity related

instruments. This financial product is more suited to those investors who are willing to take high risk

and looking for high returns. There is no upper limit on investments that can be made in ELSS. However investments

up to INR 100,000 made in ELSS in a financial year qualify for deduction from taxable income under Section 80C of the Income Tax Act.

ELSS comes with a 3 year lock-in period. Long term capital gains earned on investments from ELSS are tax free. Also dividends earned from ELSS plan are tax free in the hands of the investor. The other tax saving instrument that comes closest to comparison with ELSS is Unit

Linked Insurance Plan (ULIP).

Advantages of ELSS Schemes:

1. Tax Benefit U/S 80C: Investor can claim tax benefit u/s 80c up to limit of Rs.1Lac. 2. One time investment: This is only one time investment unlike to LIC policies where

annual premium is payable. 3. Tax Free Maturity Benefits: Maturity amount received is completely free from income

tax. Investors with higher tax brackets have a good advantage of it. 4. Transparency: Daily NAV is declared and scheme portfolio is open for anyone. 5. Minimum Lock in: ELSS schemes have lock in period of 3 yrs which is the minimum

among the other available tax saving instruments.

Risk of ELSS Schemes:

1. Risk: ELSS returns are linked to market returns. So there will be a market risk which cannot be avoided, but high risk also come up with chances of higher returns and chances on benefits in future are quite high when a longer term horizon is considered.

2. No tax exemption: ELSS is in demand because of tax benefits. But all this interest in ELSS is set to change very soon with the advent of the 2011-2012 Direct Tax Code (DTC). Starting April 1, 2012, no new ELSS Mutual Funds will be exempted from taxes taking away one of the biggest USPs of ELSS. Despite the fact that tax benefits for ELSS funds already in existence will continue, there has been a rush among investors to exit these schemes. ELSS was considered a sort of starting point for budding investors as they made their entry into the equity market, but with the coming of the DTC this looks certain to change.

Is it still sensible to still invest in ELSS? The most important point to be noted here is that according to the revised 2011 Direct Tax Code, only ELSS Mutual Funds initiated after April 1, 2012 will not be exempted from tax deductions. This does not apply to already existing ELSS funds and funds made before the aforementioned date, so it would be wise to avail this offer while it is still available. It should also be remembered that the DTC is just a draft bill and is yet to be passed as a law. There is still a lot of time for that and significant changes are likely to happen in that time. So until it becomes an act, investors should wait and not act in haste. There is still a lot of time before the DTC comes into effect during the 2012-13 fiscal year. So it is important for the investor to have a strategy during the interim period. This is especially important for those who are using the ELSS funds for completing their tax saving investments. It should also be noted that one can add to the ELSS investment before the transition to the DTC, which is a year from now.

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