Why ELSS mutual funds are better?

As our income grows with progress in our career, savings for taxes to avail income tax deduction becomes an unavoidable exercise. One should always try saving taxes, rather than evading them, in order to have a fair income post paying the desired taxes. 

As per Income Tax Act 1961, Indian citizens are allowed to save taxes under various sections like 80C, 80D and 80EE, etc. One can claim tax deduction up to Rs. 1.50 lakh every financial year, under Section 80C. 

We will discuss tax saving options under Section 80C in this article.

You can save in bank tax saver FDs, NSC or PPF which are traditional investment options as they offer you assured returns in terms of interest payment. However, if you can take some amount of risk, you can consider investing in ELSS or ELSS mutual funds.  ELSS funds are tax saving mutual funds, which invest in equities and has a 3-year lock-in period.  

ELSS mutual funds provide the opportunity to earn good returns along with tax savings. These mutual fund schemes invest at least 80% of the scheme’s assets in equities. So, the returns you could earn on them are directly linked to the stock market’s performance. This can be a suitable option if you want to invest for long-term goals such as creating a retirement corpus or child’s education or buying a new house. 

In order to understand why ELSS mutual fund investment are called tax saving mutual funds, let us understand in detail regarding tax treatment of various 80C investments:

Tax Treatment takes place at three stages of investment:

• At the time of making the investment
• During the period of investment 
• At the maturity of the investment

ELSS mutual funds – During the first stage, there is tax saving under section 80C upto Rs 150,000 in a year. During the period of investment, there is no tax, if you have opted for the growth plan. However, if you have invested in the dividend plan, the dividends declared will be added to your income and taxed accordingly. At the time of redemption (lock-in period is only 3 years), capital gains upto Rs 1 Lakh is totally tax free and gains in excess of Rs 1 Lakh is taxed at only 10%.

ELSS mutual fund schemes can offer the highest returns among all 80C schemes as investments are made in equities. You benefit from market returns which are much higher than that of fixed returns offered by other tax saving schemes. 

PPF – On the investments, tax rebate is allowed upto Rs 150,000 in a financial year. PPF has only the growth option and whatever accumulates during the 15 year period, is tax free on maturity. 

NSC – At the time of investment, tax saving under 80C is allowed. During the tenure of investment, the accrued interest, except in the final year, qualifies for deduction under 80C, provided it is within the overall limit of Rs. 1.5 Lakhs. On maturity, if accrued interest during the tenure is not declared as income in IT returns, the accrued interest of the entire period is taxable, otherwise only the final year accrued interest would be taxable. 

Tax Saving 5 year Bank FD – On investment, tax rebate is allowed under section 80C. During the tenure of investment, interest is taxable and the bank deducts the tax at source. 

From the above, you can observe and understand that ELSS, PPF, NSC and bank tax saver FDs, all offer tax savings under the same section. However, when it comes to higher returns and the least lock-in period, ELSS mutual funds score very high.