ELSS (equity-linked saving schemes) is one of the prudent tax saving investment options better than any other financial instruments despite the LTCG (long-term capital gain) tax. Discussed here is why ELSS is still better despite levying LTCG tax and how this instrument can allow you to generate higher wealth over the long term.
ELSS is a kind of investment wherein your investible money grows quickly over the long term as this fund predominantly invests in equity instruments that yield higher returns. What makes ELSS distinct from other equity funds is that an investment of up to Rs 1.50 lakh in ELSS fund is eligible for a tax deduction. This fund comes with a lock-in of 3 years. Also, this is the only financial product in the mutual fund domain that offers tax benefits as per Section 80 C.
How tax deduction on ELSS works?
Suppose, X is a marketing team head with an MNC who earns Rs 11 lakh every year. This lands them in the 30 per cent tax slab, which is the highest tax slab. X learns about ELSS from their brother and decides to invest in an ELSS tax savings scheme. Now, as per Section 80 C, they can invest a sum of up to Rs 1.50 lakh in an ELSS fund to claim a tax deduction on the same. By investing a sum of Rs 1.50 lakh in ELSS, X’s taxable income will reduce to Rs 9.5 (11 – 1.5) lakh p.a. Also, the 3-year lock-in period will ensure the invested amount continues generating interest and allow them to form massive wealth over the long time period.
Now, let’s suppose during the 3-year lock-in period, they generated a gain of Rs 2 lakh. So, they will have to pay an LTCG tax of 10 per cent on the profit amount post deducting Rs 1 lakh from this amount as LTCG of up to Rs 1 lakh is exempted from tax in a financial year. So, here the LTCG tax will be charged on Rs 1 lakh (Rs 2 lakh – 1 lakh). Hence, on their ELSS investment, the LTCG tax charged will be Rs 10,000 (10 per cent of Rs 1 lakh).
So, despite levying an LTCG tax of Rs 10,000, the overall gains earned by X in a span of 3 years are much higher than any other tax-saving instruments because ELSS majorly invest in equities. Note that, equities as an asset class have the potential to generate inflation-beating and fixed income-beating returns over a long-term period by a wide margin.
Despite the reintroduction of the LTCG tax, ELSS still remains a prudent tax-saving instrument, which you must consider investing in to reduce your tax burden as well as create wealth over the long term. Also, note that this instrument provides you flexibility if you want to switch your plan or move to some other fund. What is best about ELSS is that it is the only tax-saving instrument that comes with the shortest lock-in period of just 3 years. However, before making any investment decisions, it is prudent to factor in your risk appetite, time horizon and your financial goals.