Save
Tax
Build
Wealth
December 2014by investing in instruments qualifying u/s 80C depends on the tax bracket
that you fall in, the savings on taxes vary and range from `15,000 to `45,000 in year
Your Savings
`15,000
under the10%
`30,000
under the20%
`45,000
under the30%
Option
The Outstanding
Invest in equity-linked saving scheme,
save tax and enjoy growth on your
investments over the long term
Contents
ELSS Advantage ...
3
Case for ELSS ...
5
What is ELSS? ...
13
Decoding savings ...
14
Alternate tax savers ...
16
Power of equity ...
18
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The information provided herein is solely for creating awareness and educating investors/ potential investors about rules of investment and for their general understanding. Readers
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them decide for themselves.
December 2014 Design: Anil Panwar
T
his is that time of the year when most salaried people are busy struggling with colleagues from the accounts department push-ing for submission of tax-savpush-ing investment proofs. Combining tax savings and wealth creation needs planning and an awareness of how money can work for itself. When it comes to tax-saving options, there is plenty to choose from such as PPF, insurancepolicies, provident fund and equity-linked saving schemes
(ELSS). The sooner you start investing in ELSS, the easier it is to accumulate wealth in the long run. Not only do
invest-ments in this product save taxes, it also
earns good returns and builds wealth in the long run.
For the uninitiated, ELSS is a type of mutual fund investment that qualifies for tax deduc-tions. It is like any other mutual fund, but invests at least 80 per cent of its assets in equity and equity-related products to
qualify for tax deductions under Section 80C of the Income Tax Act. ELSS schemes are typically open-ended. Investors can sub-scribe to the fund on any day. These investments come with a three-year lock-in and the returns from the scheme, i.e. dividends and capital gains, are tax-free. With markets
on a high, investments in ELSS to save taxes could just turn your wealth creation dream into reality.
There are several factors that work for ELSS compared to other tax-saving options under Section 80C, but the one that stands out big is the equity exposure that it offers. Unlike other tax-saving options, which have either no or little equity coverage, ELSS is the only option with significant equity exposure of more than 80 per cent, which makes it at par
with any diversified equity fund. The added advantage of the three-year lock-in with investments makes it the tax-saving option
with the shortest lock-in. There are several other inherent advantages with ELSS
that makes it a preferred choice among tax-saving options.
2
Lock-in
ELSS has the shortest lock-in of three years under Section 80C, which makes it the most liquid among tax-saving options. In comparison, the fixed return PPF has a 15-year lock-in with the flexibility of partial withdrawals from year six. One can borrow against the PPF, but it still does not match the short lock-in that ELSS offers. Even other tax savers
such as insurance plans have long tenures and so does the mandatory provident fund deduction. If liquidity is priority while saving tax, ELSS is a go-to option.
1
Diversification
ELSS being an equity mutual fund is well diversified, making it a suitable option for every investor looking to save taxes and also
invest in equities. Diversification is a simple philosophy that rests on
the fact that all investments don’t do well simultaneously. An equity mutual fund provides instant diversification because the
money invested by a fund is spread across different investments such as companies from different sectors across market capitalisations.
4
Equity exposure
Compared to other options available under Section 80C, ELSS is the only equity-oriented tax-saving option. This is perhaps the most underrated benefit of ELSS, especially when taken into account the fact that equity is the only asset class that beats inflation in the long run and builds real wealth. This factor alone makes the case for ELSS that much stronger than other
available options. Of course, like every other equity instrument, an ELSS also runs the risk of market volatility and loss. Over the long term, these risks are reduced.
3
Flexibility
There is a natural convenience built into investing in ELSS: You can invest by filling up a simple form or even online with direct debit
from your bank account. Like other mutual funds, you can invest dilligently through SIPs, which help you stagger your investments.
Most importantly, you can
invest small sums through the year instead of investing large sums
at one go. Likewise, at the time of redemption, you need not redeem all the units after the lock-in, you can cash-in as much as you need and let the rest stay invested.
6
Transparent
Investments in ELSS are open, in the sense, each month the AMC releases the portfolio in which the fund has invested for one to know the type of stocks which their investments are in, the sectors, and the exposure in debt and cash. Mutual funds are regulated by the stock market regulator SEBI, which mandates the release of daily NAVs of the fund, indicating the value of one’s investments each
day. While the lock-in is applicable for three years, one can still track the performance of their investments in these funds.
5
Tax-free returns
Investments in ELSS have dual tax benefits. First, investments of up to `1.5 lakh
in a financial year qualify for tax deductions under Section 80C of the Income Tax Act. Second, after the mandatory three year lock-in, the gains from the investments are
tax-free. Further the dividend income earned on ELSS investments is also tax-free. The beauty of investing in ELSS is that the job of making investments on your behalf in equities is left with experts. These experts professionally manage the funds to optimise returns.
ELSS schemes are floated in accordance with ELSS guidelines issued by CBDT under Section 80C of the Income Tax Act 1961 to provide tax savings on investments in equities. The amount you invest in ELSS is deducted from your taxable income. This way, you lower the amount of
income tax you need to pay. The investment limit has gone up to `1.5 lakh this financial year from the earlier `1 lakh.
7
Real-time
management
ELSS takes the difficult aspect of managing equity investing from you. There are scores of firms and sectors to track and several factors that impact the economy and markets. For instance, a change in interest rates will impact stock prices of companies of certain sectors
that are rate dependent. The role of professional fund management
ensures you do not face the task of making decisions. Mutual funds employ professionals who manage investments on a full-time basis with expert research resources. The cost of professional management is shared mutually among all the investors in a fund.
Depending on the tax bracket that you fall in, the savings on taxes vary and range from
`15,000 to `45,000 in a year by investing in instruments
that qualify u/s 80C
`
15,000
under the
10%
tax bracket
`
30,000
under the
20%
tax bracket
`
45,000
under the
30%
tax bracket
Your
Savings
ELSS and the rest
Minimum
investment (
`)
Lock-in years Returns (%) Tax treatment Risk profilePublic Provident Fund (PPF)
500
158.70%
Interest tax-free Low National Saving Certificate(NSC)
100
5 - 108.5-8.8%
Interest income taxable Low Bank FD with 5-yr lock-in1,000
58.5%
Interest income taxable Low Senior Citizens SavingsScheme (SCSS)
1,000
59.2%
Interest income taxable Low Equity-Linked SavingScheme (ELSS)
500
3 Market-linked Dividend and capital gains tax-free HighThere are several financial instruments in savings and investments that qualify for tax deduction under Section 80C. These include provident fund, PPF, premiums towards life insurance policies, NSC, ULIPs, bank FDs with 5-year lock-in, home loan repayment, tuition fees for children with limits besides ELSS. While
some of these are mandatory for salaried people like PF, some options are expenses in nature such as fee towards education of children. Among investments, the ELSS can be compared to PPF and the NSC, where one has the choice to invest of their own accord.
Wheel effect
Suppose you make investments of `1.5-lakh under Section 80C by investing in an ELSS for three consecutive years. In the fourth year, you have the right to redeem the first year’s ELSS investment, which will be tax-free. This sum can be re-invested as fresh investment on which deductions can be claimed. This way, without committing fresh capital, you will have a long-term, saving cycle. You set a continuing tax-saving mechanism in an ELSS that not just saves you taxes but also frees you from making any fresh investments after the initial three years.
Smart Way to
Tax Saving
60 lakh 50 lakh 40 lakh 30 lakh 20 lakh 10 lakh 0 1994 On March 31 Fi gu re i n ` 2014The power of equity
If you invested `70,000 each year in PPF, representing tax-saving debt options from March 1994 when the return on PPF was 12 per cent till March 2014 when the return was 8.7 per cent, `14.7 lakh would be worth `38.7 lakh at an annualised 8.8 per cent return. In the same period, if you invested in Nifty, representing equity investments, the corpus would be worth `57.2 lakh at 12 per cent annualised returns.
The short lock-in of ELSS makes it a convenient instrument to create a cyclical investment plan, which can go a long way
PPF: 38.7 lakh PPF: 11.3 lakh PPF: 25.6 lakh Nifty: 57.2 lakh Nifty: 42.2 lakh Nifty: 62.7 lakh 2003 2010
Income stream
The same logic of investing in an ELSS for consecutive years can be used to create tax-free income streams after the mandatory three-year lock-in. The short
three-year lock-in in an ELSS can be used gainfully to create an income stream in later years and also save taxes.
Just like the Swiss army knife, which has multiple benefits, an ELSS too
has several advantages. It is a
tax saver, investment option and can
turn into an income stream. No other tax-saving option comes close to the benefits an ELSS offers, making it not just an ideal tax-saving instrument but also a possible first mutual fund scheme that one could consider investing in.
Disclaimer
As part of its Investor Education and Awareness Initiative, HDFC Mutual Fund has sponsored this booklet. The contents of this booklet, views, opinions
and recommendations are of the publication and do not necessarily state or reflect views of HDFC Mutual
Fund. HDFC Mutual Fund does not accept any liability arising out of the use of this information. Any calculations made are approximations, meant as
guidelines only, which you must confirm before relying on them
