Explaining Elss mutual funds and how they work

Equity Linked Savings Scheme, better known as ELSS Funds or Tax Saving Mutual Funds allow an individual or HUF to invest in a diversified equity mutual fund to claim a deduction up to Rs. 1.5 Lakhs under Section 80C of the Income Tax Act 1961.

These funds allow an investor to claim dual benefits of tax saving along with availing equity growth.

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What are tax saving mutual funds?

Elss means tax saving mutual funds that allow tax deductions under 80c of the Income tax act.

Tax saving mutual funds have a short lock in period of 3 years as opposed to other tax saving instruments with lock in period ranging from 5 to 7 to 10 years.

Elss mutual funds is your best option since it provides both tax saving as well as capital appreciation.

To get the true benefits of elss funds, they should be first looked at as an investment and a tax-saving option later.


Additional reading: Click Here to read our complete review of Axis Long Term Equity Fund 

How does tax saver mutual fund work?

A tax saving mutual fund is similar to a flexi cap mutual fund in the sense that it does not have any restrictions with regards to caps.

It is free to invest wherever it wishes to as long as 80% of the portfolio is invested in equities at all times.

It comes with a lock in period of 3 years, for sip each instalment would need to complete 3 years before you can withdraw it.

Since it comes with a lock in period of 3 years, fund managers have a sense of stability in terms of AUM which provides them with more room to take concentrated bets.

Every tax fund is managed differently from the other since there are no set rules as such.

Therefore, relying merely on past returns can be very harmful for your portfolio, instead a better understanding of the philosophy of the fund and your needs is what is required.



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Is ELSS taxable after 3 years?

Elss funds are taxed like any other equity mutual fund.

No tax is imposed for profits under Rs 1 lakh.

For profits exceeding Rs 1 lakh, 10% Long Term Capital Gains tax (LTCG) is imposed.

Short Term Capital Gains tax (STCG) cannot be imposed on tax saving mutual funds since they have a lock in period of 3 years so by default, they stay invested for more than a year.


Can I withdraw tax saver mutual fund?

You can withdraw your elss funds only after they have completed 3 years.

For SIP investments in tax saving funds, each sip instalment is considered as a fresh purchase and therefore each SIP instalment would need to complete 3 years.

No partial redemptions or transfers are allowed before the completion of 3 years.

Additional reading: Click Here to read our complete review of  Reliance Tax Saver Fund 


Is ELSS good for long term investment?

Even though elss funds come with a 3 year lock in period it is better to invest in them with a longer time horizon, say 7 years or more.

This is because most elss funds work more or less like a flexi cap mutual fund.

Therefore your tax saving funds would not be restricted by caps and would be invested across the market.

They serve dual purpose of investments as well as tax savings.

Therefore, while you are saving taxes, you could also use the taxes saved for a long term goal.


Benefits of ELSS Funds

Tax saving

The first and most obvious benefit is that it helps you in reducing your taxable income significantly.

You can invest up to Rs 1,50,000 in elss funds to save yourself from paying taxes to that amount.

Even though tax saving is the most obvious benefit, tax saving mutual funds should be planned as much as the rest of your portfolio.


Lowest lock in period

Elss funds have the lowest lock in period among all the tax saving instruments



Lock in period

Elss funds

3 years

Public Provident Fund

15 years

National Savings Certificate

6 years

Bank Fixed Deposits

5 years


Highest Returns

Elss funds have the potential to generate the highest returns from all the tax saving instruments.

This is because elss funds by rule need to invest mostly in equity.

Therefore, tax saving funds also have the most potential to generate inflation beating returns.

Tax saving mutual funds have the most potential to transform your money into wealth.


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Elss funds and other tax saving instruments

Elss is not the only tax saving instrument but it is the most rewarding of the lot.


Elss and National Pension Scheme (NPS)

NPS is more for your long term and retirement goals whereas elss funds can be used for medium term to long term goals.

Medium term goals here mean from 5 to 7 years and beyond.

Elss funds can be redeemed anytime after 3 years whereas NPS can be redeemed only once you retire.

Elss funds allow for tax deductions up to Rs 1,50,000 whereas NPS allows for up to Rs 2,00,000.


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Elss and Tax Saving Fixed Deposit

Tax saving fixed deposit has a 5 year lock in period whereas elss funds have a lock in period of 3 years.

Historically speaking, elss funds on an average have generated better returns than tax saving fixed deposit.

Interest income from tax saving fixed deposit, irrespective of the amount is added to taxable income whereas for elss funds only profits above Rs 1,00,000 are taxed at 10%.



Elss and ULIP’s

Ulip’s are a mix of insurance policy along with exposure to either debt or equity.

It provides the best of neither though.

Ulip’s have high costs and low transparency as compared to elss funds.

Ulip’s have a lock in period of 5 years whereas elss funds have of 3 years.

Returns from ulip’s are tax free while profits over Rs 1,00,000 in elss funds are taxed at 10%.


  Tax saving mutual funds can be a good stepping stone in the world of equity investing if you are a first time investor. Not only does it help to save taxes but also helps in capital appreciation.

  Since your money is locked for 3 years you have no option than to sit tight through the various volatile phases. This helps you become a more disciplined investor along with understanding the virtue of patience when it comes to equity investing.

  This is unlike other open ended equity funds where you can move in and out after a year without any exit load.


For portfolio enquiriesemail us with your doubts at info@themutualfundguide.com

Disclaimer : While due precaution has been undertaken in the preparation of this article, The Mutual Fund Guide or any of its authors will not be held liable for any investments based on the above article. The above article should not be considered financial advice and has been published only for your perusal. Due credit has been given in case wherever required, in case you feel any part violates any rights then do get in touch with us and we shall get it duly removed.  
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