Tax saving is a priority of every salaried/ self-employed individual at the end of financial year. Majority of people invest in financial instruments such as public provident fund (PPF), LIC, Equity Linked Saving Scheme (ELSS), tax saving fixed deposits (FD) with the banks, National Saving Certificate (NSC) etc. to avail tax benefit up to Rs 1.5 lakh per annum under section 80C of the Income Tax Act 1961. However, from all the aforesaid tax-saving financial options, ELSS is the most preferred option as it offers dual benefit of tax saving and higher returns in the long run as compared to other tax-saving investments. Here are some of the reasons that make sense why ELSS is the best tax saving scheme vis-à-vis other tax saving instruments.
Gives investment option
There are two options while investing in ELSS - growth option and dividend option.
Growth option: In growth option, the investors will not get any dividends from the mutual fund house but will get a lump sum on the completion of lock-in period of 3 years which will help appreciate Net Asset Value (NAV) and thereby multiply profits.
Dividend option: On the other hand, in dividend option, the investors get the timely benefits of dividends. Moreover, dividends received by investors are not liable for taxation by the government and thus investors get the entire amount. On the other hand, interest earned on 5-year tax-saving FDs with banks is taxed.
Shortest lock-in period
Lock-in period for ELSS is 3 years while other tax-saving instruments like LIC, tax-saving FD with bank, NSC etc. have a lock-in period of around 5 to 15 years or more. The shortest lock-in period provides the investors with increased flexibility to withdraw money from the scheme when they need it.
ELSS basically invests in equity market. Hence, it has great potential to generate better returns than other tax saving options. In recent years, ELSS has generated an average return of 15% per annum in 5 years, whereas FD with banks has given a return of 8.50% per annum for the tenure of 5 years. It is believed that ELSSs are ideal for the first time investors in the share market. The lock-in period would help the investors to withstand the stock market volatility. Also, the fund manager in ELSS can have a buy-and-hold strategy to maximize returns.
An investor can claim tax deduction up to Rs 1.5 lakh per annum under 80C of The Income Tax Act 1961. Suppose, if a person’s annual income is 12 lakh, total tax to be paid will be Rs 1.91 lakh. However, if he/she makes investment in ELSS scheme, she/he can save tax of Rs 46,350 (30% tax bracket) and is required to pay Rs 1.44 lakh as a total tax.
Systematic Investment Plan (SIP)
ELSS fund provides the facility of SIP (Systematic Investment Plan) wherein you can invest a fixed amount every month instead of a lump sum amount at once. If you start a SIP in ELSS at the beginning of a financial year, you are more likely to get better return than investing in last few months of the financial year.
Protection from Inflation
ELSS funds generate returns that are able to weather inflation. While bonds and fixed deposits offer returns that may seem in sync with rising inflation over a period of time, yet in practical, the real returns are relatively quite low. As ELSS funds are equity-based and returns are not taxable, they generate higher gains as compared to other tax saving instruments, which are in line with the pace of inflation.
Long-Term Investment Options
There is false impression about ELSS that fund has to be withdrawn or re-invested elsewhere on the completion of the lock-in period. However, this is not the case with ELSS funds, investors can continue with ELSS if the fund is performing well. ELSS funds give you a choice to stay invested after the lock-in period, if you wish to. If the ELSS fund is a well-diversified scheme, you should consider for long-term investment.
The benefit of investing in ELSS funds for saving taxes is that it offers better returns. Most of the government-backed tax-saving instruments offer modest returns. It has been proved by numerous studies that stocks have potential to generate far better returns than other asset classes over a long period of time.