Section 80C of the Income Tax Act allows investors to claim a deduction of up to Rs. 1.5 lakh per financial year on investments such as the Public Provident Fund, Senior Citizen Savings Scheme, and National Pension Scheme. While these government-backed vehicles offer near-guaranteed returns, they often come with long lock-in periods and relatively lower returns compared to market-linked vehicles.
For long-term investors looking for options with higher growth potential, Section 80C also includes Equity Linked Savings Schemes, also known as tax saving mutual funds. Contributions made to such funds allow investors to deduct a maximum of Rs. 1.5 lakh from their taxable income, helping them reduce their tax burden.
Let’s understand the 80C ELSS tax benefit in detail while also drawing comparisons with other tax-saving investment options.
What is ELSS and How Does it Work?
Equity Linked Savings Schemes, or ELSS, are a type of equity mutual fund. Due to the ELSS scheme tax benefit under Section 80C, these schemes are also known as tax saving mutual funds. As you can guess by the name, ELSS invests primarily in equities. At least 80% of the fund’s assets are invested in stocks, which while offering the potential for higher returns, also come with market risks. This makes ELSS a high-risk, high-reward investment option for aggressive, long-term investors looking to save tax while creating wealth.
ELSS have a lock-in period of three years, during which withdrawals cannot be made. This is
the shortest lock-in period among all Section 80C options. For example, investments in popular options like SCSS, NSC, and ULIPs are locked in for 5 years. Similarly, PPF investments cannot be fully withdrawn until 15 years, which makes them far less liquid compared to ELSS.
Other than attractive returns and a shorter lock-in period, the main draw of these funds is their tax efficiency. Not only do they offer the Rs. 1.5 lakh deduction benefit under 80C but since they are locked in for three years, only long-term capital gains tax can be levied on them.
Due to this, an ELSS tax exemption applies to capital gains up to Rs. 1.25 lakh per financial year. Also unlike certain other instruments like the PPF, where one can only invest a maximum of Rs. 1.5 lakh per year, there is no upper limit to the amount one can invest in ELSS.
How Does It Work?
Like any other mutual fund, ELSS pools money from a large number of investors and invests it primarily in stocks across various sectors and market capitalisations like small, mid, and large-cap companies. This diversified portfolio is managed by an expert fund manager, who along with a team of analysts, conducts thorough market research, identifies trends, analyses conditions, and evaluates various companies’ financial health.
One can either invest a large lump sum amount in one go or take the SIP route and make regular contributions towards their investment. Each SIP instalment counts as a separate investment, so each instalment will have its own 3-year lock-in period. This is important to keep in mind because if you invest through SIPs, you won’t be able to withdraw all your units at the same time.
Choosing between the lump sum and SIP depends on an investor’s preference, risk tolerance, time horizon, and general market outlook. Since investing a large lump sum in one go can be risky, many investors choose to go with SIPs and lower the risk. SIPs offer the benefit of rupee cost averaging, which means when the market is down and the fund’s NAV is low, more units can be bought.
On the other hand, when the NAV is higher, fewer units are bought for the same amount of money. This averaging effect can lower the overall cost of investment. If you’re wondering which mode would be more suitable for your situation, consider consulting with a mutual fund investment planner, who can also help you sift through the many ELSS funds available in the market and help you pick the ones that align with your goals and risk tolerance.
ELSS Tax Benefits Under Section 80C
By investing in an ELSS tax saving fund, you can claim the Section 80C deduction of up to Rs. 1.5 lakh in a financial year. This amount can be deducted from your taxable income, reducing the overall tax liability. Section 80C benefits can only be availed under the old tax regime, where the highest tax slab rate is 30%. Thus, one can save up to Rs. 46,800 tax in a financial year by investing in ELSS. (30% of Rs. 1.5 lakh = Rs. 45,000 plus 4% cess on Rs. 45,000 = Rs. 1,800).
Section 80C tax benefit has a maximum limit of Rs. 1.5 lakh across all the instruments eligible for deduction. For example, if you invest Rs. 1 lakh in PPF and Rs. 1 lakh in ELSS in a financial year, only Rs. 1.5 lakh can be claimed as a deduction even though you invested Rs. 2 lakh.
Other Benefits
Besides the 80C ELSS tax benefit, ELSS also offers a long-term capital gains tax exemption of up to Rs. 1.25 lakh per financial year. Any LTCG exceeding this amount is taxed at 12.5% without indexation. Investors can use strategies such as structured withdrawals and tax loss harvesting to take maximum advantage of this provision. A tax consultant can guide you through the various ways you can capitalise on Section 80C deductions and minimise the LTCG tax burden.
Steps to Claim ELSS Tax Benefits
To claim the Section 80C ELSS tax benefit, you must first ensure that you are filing your income tax returns under the old tax regime. The new regime is the default and does not allow most deductions and exemptions allowed under the old structure. Instead, it offers lower tax rates. Also, make sure to keep the necessary proofs of investment handy as you need to submit them while filing your income tax return.
Profits made from ELSS are classified as LTCG due to the 3-year lock-in period. LTCG gains for equity mutual funds are exempt up to Rs. 1.25 lakh per financial year. With guidance from professional tax consultation services, you can make the most out of this ELSS tax exemption.
ELSS vs Other Tax Saving Investments
Here’s how ELSS tax saving mutual funds differ from other 80C tax saving options in terms of returns, risk, and lock-in periods:
| Investment Name | Returns | Lock-in Period | Risk | Tax Benefits |
| Equity Linked Savings Scheme | Offers market-linked returns which can be potentially very high as over 80% of the fund’s portfolio consists of equities. | 3 years | Risk in the short term is very high, however, over a longer period risk tends to reduce a bit as market volatility evens out. | Up to Rs. 1.5 lakh can be claimed as a deduction per year under 80C. ELSS mutual fund tax benefit also includes a Rs. 1.25 lakh tax exemption on LTCG per financial year. |
| Public Provident Fund | The rate is announced by the government every quarter. 7.1% p.a. for Q4 FY 2024-25 | 15 years (Partial withdrawals allowed under certain conditions) | Low | PPF is an example of an EEE instrument. The principal amount, interest earned on the investment, and the maturity, are all exempt from tax. |
| Senior Citizens Savings Scheme | Rates are regularly updated by the government. 8.2% p.a. for FY 2024-25 | 5 years | Low | Up to Rs. 1.5 lakh deduction under Section 80C. Interest is taxable and attracts TDS if it exceeds Rs. 50,000 per year. |
| National Pension Scheme | Moderate market-linked returns depending on chosen asset allocation. | Until the age of retirement. (Partial withdrawals allowed under certain conditions) | Low | NPS investors can avail of an extra deduction of up to Rs. 50,000 under Section 80CCD (1B), which is in addition to the 80C Rs. 1.5 lakh deduction. (A total of Rs. 2 lakh can be claimed) |
| Tax-Saver Fixed Deposits | 5.5% to 7.75% p.a. | 5 years | Low | Contribution can be used to claim Section 80C deduction of up to Rs. 1.5 lakh. Interest earned from FDs is fully taxable as per the investor’s slab rate, and may also attract TDS if it exceeds a certain amount per year. |
| National Savings Certificate | Rates are updated by the government regularly. 7.7% p.a. for Q2 FY 2024-25 | 5 years | Low | Up to Rs. 1.5 lakh deduction under Section 80C. |
| Unit Linked Insurance Plans | Returns are market-linked and depend on the type of mutual fund chosen by the investor. Range from high to moderate. | 5 years | Depends on the type of funds chosen. Low risk for debt funds, moderate for hybrid funds, and high risk for equity funds. | Other than the maximum Rs. 1.5 lakh deduction under 80C, the maturity proceeds of ULIPs are tax-free under Section 10(10D). The latter is true only if the annual premiums are not more than Rs. 2.5 lakh. |
Best Practices to Maximize ELSS Tax Benefits
1. Invest at the Beginning of the Financial Year
Investing early gives you the time needed to assess the different aspects of an ELSS, like the fund house’s AUM and reputation, the fund manager’s track record, the fund’s expense ratio, past returns, and risk-adjusted returns. If you make a decision in a hurry near the end of the financial year, chances are you might not get the best possible result.
Also important is to align the fund’s investment strategy with your financial goals, risk appetite, and investment horizon. In a hurry, one may simply chase past returns and invest without considering the fund’s long-term consistency, which can lead to suboptimal results. Even the market conditions might not be favourable for an investment as you near the deadline, which is another thing to keep in mind.
2. Choose SIP over Lump Sum Investment
While both modes of investment have their own advantages, you must consider your financial situation and market conditions before deciding which path to take. Generally, SIPs are more favourable as they take advantage of rupee cost averaging and lower the average cost per unit. However, if the time is right, a lump sum investment can be a powerful way to boost your returns, even if a little risky.
3. Hold ELSS Investments Beyond 3 Years
Even though the lock-in period of ELSS is just 3 years, one can hold the investment and continue to stay involved for long-term growth. Short-term market fluctuations can make investing in equities risky, but they tend to smoothen out over a long period, which is why it is often recommended to take a buy-and-hold approach when investing in such instruments. When redeeming your investment, be sure to structure your withdrawals in a way that maximises the ELSS scheme tax benefit on LTCG exemptions to lower taxes.
4. Diversify Among Different ELSS Funds
You can consider investing in a number of ELSS funds to diversify and lower the risk even further. Be mindful of mutual fund portfolio overlap, which occurs when different funds hold the same stocks. This can reduce diversification and increase risk, which is why you should use a mutual fund planner to analyse how much overlap there is in your portfolio.
Common Mistakes to Avoid While Claiming ELSS Tax Benefits
- To claim the ELSS tax benefit, you need to make sure that you are filing your income tax returns under the old tax regime. The new tax regime does not allow deductions under Section 80C and also happens to be the default regime.
- When filing your ITR, you’ll need to provide proof of investment in ELSS. Make sure to keep all related documents, statements, and receipts so the process to claim deduction is smooth.
- While ELSS tax saving mutual funds offer several tax benefits, LTCG above Rs. 1.25 lakh in a year attracts a tax of 12.5%. If you plan your withdrawals accordingly, you can minimise LTCG tax.
- Waiting till the end of the financial year to make an ELSS investment can turn out to be a poor decision due to a lack of research and unfavourable market conditions. Plan for your investment by analysing various parameters like past returns, AMC’s AUM, the manager’s expertise and philosophy, expense ratios, and past performance consistency, and aligning the fund with your personal financial situation, goals, and risk tolerance.
Conclusion
ELSS tax saving mutual funds offer tax deductions of up to Rs. 1.5 lakh under Section 80C. Since these funds invest heavily in equities, their potential returns as well as risk levels are higher compared to other tax-saving options like the PPF. They are suitable for aggressive, long-term investors who want to create wealth while enjoying the mutual fund tax benefit ELSS offers.
At just 3 years, their lock-in period is the shortest among all 80C instruments. However, since they are equity-oriented funds, they perform best when given a longer investment horizon beyond the 3-year lock-in period.
