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Tax benefits of investing in ELSS

Want to know the tax benefits of ELSS mutual funds? Read to know about the tax deductions and benefits of investing in equity-linked savings scheme.
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ELSS gives the ideal combination of tax benefits and wealth creation

For some individuals, the primary objective for making investments is wealth creation and for some individuals, it is tax saving. However, the Equity Linked Savings Scheme (ELSS) gives you the ideal combination of both; wealth creation as well as tax benefits and wealth creation. This article will help you understand the tax benefits of investing in ELSS.

Section 80C tax benefits

The Income Tax Act provides deduction from taxable income for investing in certain financial products. The maximum deduction allowed is Rs. 1,50,000 in a financial year. Some of the financial products eligible for deduction under Section 80C include:

  1. Life insurance
  2. EPF and PPF
  3. Equity Linked Savings Scheme (ELSS)
  4. 5-year bank fixed deposit
  5. Post office schemes
    • Fixed deposit
    • National Savings Certification (NSC)
    • Senior Citizens Savings Scheme (SCSS)
    • Sukanya Samriddhi Yojana, etc.

Tax benefits on ELSS investment

Investment in ELSS is eligible for a deduction from taxable income under Section 80C. The maximum deduction allowed in a financial year is the amount invested or Rs. 1,50,000, whichever is lower. Please note that there is no maximum limit on the amount that can be invested in ELSS. However, the tax deduction under Section 80C is limited to Rs. 1,50,000 in a financial year.

The ELSS has a lock-in period of 3 years. If you are investing using the systematic investment plan (SIP) mode, each SIP instalment will have a lock-in period of 3 years from the date of investment.

ELSS can help you save Rs. 46,800 in taxes every financial year

Under the old income tax regime, depending on the income slab you fall in, your net tax savings can go up to Rs. 46,800.

Income SlabTax rateSection 80C deductionTax saving4% cessTotal tax saving
Rs. 2,50,000 – Rs. 5,00,0005%Rs. 1,50,000Rs. 7,500Rs. 300Rs. 7,800
Rs. 5,00,001 – Rs. 10,00,00020%Rs. 1,50,000Rs. 30,000Rs. 1,200Rs. 31,200
Above Rs. 10,00,00030%Rs. 1,50,000Rs. 45,000Rs. 1,800Rs. 46,800

Note: The above tax rates are applicable as per Budget 2021.

The above table shows how an investor falling in the 30% tax bracket can save a maximum of Rs. 46,800 in a financial year by investing Rs. 1,50,000 in ELSS.

Taxation at the time of redemption

The profit made on selling equity shares or equity mutual fund units is known as a capital gain. The capital gain tax at the time of redemption of mutual fund units depends on the duration of your holding.

  1. Short-term capital gains (STCG) tax: If you sell your equity shares or equity mutual fund units before one year, then STCG tax is levied at a flat rate of 15% on the gains. The STCG rate is fixed at 15%, irrespective of the income tax bracket that you fall in. However, in the case of ELSS, since there is a 3-year lock-in, the STCG tax will not come into the picture.
  2. Long-term capital gains (LTCG) tax: If you sell your equity shares or equity mutual fund units after one year, the first Rs. 1,00,000 LTCG (profits) in a financial year is exempt from taxation. The LTCG tax is levied at 10% (with no indexation benefit) on the incremental LTCG (profits). If you are investing through the SIP mode, the one-year holding period will be counted for each SIP instalment to determine the application of LTCG.

Tax harvesting

Tax harvesting is the process of booking LTCG of up to Rs. 1 lakh every financial year. It involves selling profitable units from your ELSS holdings that have completed one year. With this process of booking LTCG of Rs. 1 lakh, you can save a net tax of Rs. 10,000 (LTCG is applied at 10%).

For example, assume that your investment portfolio generates Rs. 1 lakh LTCG every year. 

Scenario 1: If you book profit after five years, you will have an LTCG of Rs. 5 lakhs. Out of this, the first Rs. 1 lakh LTCG will be exempt, and you will have to pay Rs. 40,000 as LTCG tax on the remaining LTCG of Rs. 4 lakhs. 

Scenario 2: But, if you keep booking LTCG of Rs. 1 lakh every year by selling the ELSS units and buying them back again, then two things will happen:

  1. The LTCG of Rs. 1 lakh will be exempt every year, thus saving you Rs. 10,000 in net taxes every year.
  2. You will sell the ELSS units you bought more than a year back and buy them back at the current net asset value (NAV). The current NAV will be higher than the earlier NAV, which will increase your purchase price and thus reduce your future LTCG. Please note, LTCG on equities does not give indexation benefits. So, it makes sense to sell the earlier bought units after one year and buy them back at the current NAV to reduce the future LTCG.

Benefits of tax harvesting

ParticularsNot applying tax harvestingApplying tax harvesting
LTCG in 5 yearsRs. 5 lakhs (Rs. 1 lakh/year)Rs. 5 lakhs (Rs. 1 lakh/year)
Taxable LTCG (1st Rs. 1 lakh exempt)Rs. 4 lakhsNone
LTCG tax (10% of LTCG)Rs. 40,000Nil
Net savingsRs. 10,000 (10% of 1st Rs. 1 lakh exempt)Rs. 50,000

The above table shows how you can use tax harvesting to your benefit to save LTCG tax.

Investing in ELSS with Glide Invest App

In the above section, we saw how an ELSS could give you income tax benefits at the time of investment and how it is tax-efficient at the time of redemption using tax harvesting. You can partner with the Glide Invest App for your financial planning journey to get recommendations for the appropriate ELSS and other mutual fund schemes based on your risk profile. You will get advice on planning and systematically investing towards your financial goals

With Glide Invest, you will get guidance for:

  1. A personalised risk profile assessment
  2. Identifying your financial goals
  3. Appropriate asset allocation
  4. Making a financial plan for each goal
  5. Automating the financial plan
  6. Review and analysis of your financial plan 
  7. Hand holding you till your financial goals are achieved

To start investing towards your financial goals, download the Glide Invest App from Google Play Store or Apple App Store and get started.

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