ELSS vs traditional tax saving instruments

At the end of every fiscal year people receive mails from their office HR team to submit investment proof to avoid tax deductions. Now those who are new to tax planning should understand that both tax planning and retirement planning are two long term investment objectives that should top the list of financial goals of most investors. You are going to continue to pay taxes till you retire and at the same time, you must make sure that you have a decent retirement corpus that can help you sustain for at least 20 years post retirement. Also, it is never a wiser option to make a last minute investment in tax saving schemes. Investors should discuss with their financial advisor and invest right at the beginning of the fiscal year so that submitting tax proof also becomes easier.

Most tax paying individuals prefer traditional Tax saving instruments because they feel these investments are risk-free. What these individuals fail to understand is that no investment is entirely risk free and there always some risk attached irrespective of where you invest. Traditional tax saving schemes come with lengthy lock-in periods. This means, in case of a financial emergency investors cannot redeem or withdraw from either of these traditional tax saving instruments. Most traditional tax saving instruments come with lock-in periods that may range anywhere between 5 to 15 years or even till you retire. Also, these investment schemes offer fixed interest rates which are generally on the lower side. With such low interest rates, one may not be able to achieve a decent corpus in the long run. Thanks to the introduction of a tax saving mutual fund scheme like ELSS, investors can not only achieve long term capital appreciation but also save tax in the process.

What is ELSS?

Equity Linked Savings Scheme (ELSS) is an open ended tax saving equity scheme that comes with a three year mandatory lock-in and a tax benefit. The three year lock-in ensures that the invested amount continues to earn interest for straight 36 months.

Here’s an example to help you understand how ELSS works:

Supposed you earn Rs. 12.5 lakhs per annum and want to bring down your tax liability, you can invest up to Rs. 1.5 lakhs per fiscal year and claim tax deductions for the same. That’s because according to Section 80C of the Indian Income Tax Act, 1961 a tax paying individual can invest up to Rs. 1.5. lakhs per fiscal year and claim tax deductions for the same. So, by investing Rs. 1.5 lakhs annually you have brought down your tax liability to Rs. 10 lakhs (12.5 – 1.5) by investing in ELSS. This also means that at the end of the three year lock in period you will have saved Rs. 4.5 lakhs plus interest that you will earn during the lock-in period.

ELSS vs traditional tax saving instruments: Which is better?

There are several reasons why ELSS is a far more better tax saving option as compared to conservative tax saving schemes. To begin with, ELSS comes with the shortest lock-in period among other tax saving instruments. Investors can withdraw the capital gains earned in these three years or continue remaining invested till their investment objective is achieved. Also, historically ELSS funds have offered far better capital appreciation as compared to traditional tax saving instruments. If you have long term financial goals like building a retirement corpus or buying your dream home or if you want to send your children overseas for foreign education, then you can consider investing in ELSS.

Since ELSS invests predominantly in equity and is a high risk investment, investors should consult a financial advisor before investing.