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Hands down, ELSS is one of the best tax-saving options available to young investors, given its transparency, low-cost nature and ease of investment.
At Finbingo, we believe that knowledge is power. As a knowledgeable investor, we want to empower you with the proper knowledge to make better decisions with your money.
In this post, you will learn about the tax rules on ELSS and also learn some useful tips to maximize the benefits of investing in ELSS.
Taxation Step #1: On Investing:
There is no limit on the amount of money you can invest in an ELSS scheme and across all schemes. However, under Section 80C of the Income Tax Act, the maximum tax benefit you can get from your ELSS investments per year is limited to INR 1,50,000.
Taxation Step #2: On Dividend Received:
This step is applicable only if you have chosen Dividend Payout Mode at the time of investment.
Earlier, before paying dividends to you, the mutual fund company had to pay “dividend distribution tax” to the government on the “gross” amount. Therefore, the net dividend in your hands was tax-free.
However, after changes in the Finance Act, 2020, dividend income is now taxable in your hands as per your tax slab. Further, if the amount of dividend exceeds Rs 5,000, it will be subject to TDS which is currently 7.5%.
Due to the above, opting for dividend payment mode for your ELSS investments is not a very tax-efficient option. We do not recommend it. Dividend payout also removes the benefit of compounding which is essential for wealth creation.
So in our view, you should always choose the growth option at the time of investment. If you already have ELSS investment running on dividend mode, you can request your mutual fund to switch it to growth mode.
Taxation Step #3: On Withdrawal (Redemption):
The money you invest in an ELSS scheme is subject to a lock-in period of 3 years. So, you cannot withdraw that money at all.
Once the lock-in period is over, the question of tax liability will arise only when you withdraw the money. Unless you withdraw the money, the question of tax liability does not arise.
The gains you make when you withdraw money are called “long-term capital gains” in tax parlance. This Long Term Capital Gain (combined with any other long term capital gain from Equity Mutual Fund) Tax-free up to INR 1 Lakh.
Practically, if you are new to the investment journey, your investment corpus will not be much in the initial years. Hence, the chances of you being taxed while encashing ELSS are very less.
Even after increasing the amount, you can easily plan your withdrawal so that the LTCG is less than INR 1 Lakh and hence the tax effect remains nil.
Tips to Make the Most of ELSS Taxation Provisions
If you are clear about the tax provisions and planning to invest in ELSS, it is a wise decision and we congratulate you for taking this first step. However, we also have some more tips for you below to help you get the best return on your ELSS investment till the last buck:
- Do not invest blindly in ELSS for tax benefits. First consider your financial goals, risk appetite and asset allocation and then invest.
- Even though it comes with a short lock-in period of 3 years, ELSS is a long term investment. Try to stay invested and do not withdraw money for at least 5 years. The longer you stay invested, the more you reduce the risk of market volatility and increase compounding, which helps you create long-term wealth.
- Since your investment is locked for 3 years, spend a good amount of time researching the scheme at the time of investment itself. Prefer schemes from reputed mutual fund houses with good track record. This will help reduce the chances of you getting stuck in a substandard scheme and need to switch to a different scheme after the lock-in period is over.
- Even though long-term capital gains or dividends are tax-free, don’t forget to disclose the same tax return under the “exempt income” section.
conclusion
ELSS is a super transparent investment avenue. If the redemption is well planned then the impact of taxation on the investment is also zero. Moreover, the ease of investment and the low-cost nature of investment make it an ideal tax saving option for young investors.
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