Why Should You Invest in ELSS to Save Tax?

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You can save tax every year by investing in tax-saving products. Section 80C, which is the most popular section to invest in tax saving products under the Income Tax Act, is Section 80C. This section allows you to claim tax benefits for investments up to Rs.1.5 lakh depending on your tax brackets. The salaried class is required to have employees PF, while the rest can be chosen at their own discretion. These could include bank PPFs, life or health insurance policies and postal savings schemes. These products can be used to save taxes, or are they also good for generating additional income or returns. These products can help you save taxes while still offering single-digit returns. Have you ever considered what it would look like to receive double-digit returns on your tax savings products? If you’re wondering if such financial products exist, the short answer to your question is YES.

When choosing investments instruments, it is important to consider risk appetite, lock-in periods, and the potential for higher risk adjusted returns. ELSS, or Equity-Linked Savings Schemes, are offered by mutual funds and offer three main advantages: they can help you save taxes, create wealth, and have a shorter lock-in period (3 years).

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You can also invest in Equity-Linked Savings Schemes which are eligible for tax rebates under Section 80C. These mutual funds invest primarily in equity, just like other equity mutual funds. They also come with a three-year lock-in period. They differ in two ways from other equity mutual fund types. First, investments of up to INR 1.5 lakhs per financial year are eligible for a tax rebate. Other mutual funds do not have this tax benefit. Secondly, ELSS mutual fund come with a lock in period that is not available for other mutual funds.

Let’s now look at the benefits of ELSS investments over tax-saving products. ELSS funds offer the same tax benefits as other products eligible under Section 80C of the IT Act. However, there are two distinct advantages. They have a shorter lock-in period than many products with at least five years. Second, traditional tax savings products have a lower return rate in single digits. Although past performance is not an indicator as to what mutual funds will return, historical data from mutual fund industry shows that many tax-saving mutual funds have returned higher than traditional products.

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Let’s now see how ELSS funds could help you build wealth. Let’s suppose you have at least 20 years before becoming a senior citizen. You will likely have a lower tax burden then. To save tax, you will need to make an investment every year in Section 80C. Let’s say you decide to put a fixed amount of Rs.50,000 each year into an ELSS fund. If you assume a conservative rate of return of 12% per annum and a 20-year investment, then your total investment will be Rs.10 lakhs. What would you get at 20 years? The returns from each year will compound each year. A staggering Rs.40.35 crores!

Let’s now see what happens if you put the same 50k every year into a PPF, or any other traditional product where we assume that you earn 8.25% per annum. Over the next 20 years, you end up investing 10 Lakhs and earning Rs. 25.46 lakhs. Investing in an ELSS is a smarter decision. Even a 4% annual return difference can result in 60% more wealth. This is the beauty of compounding.

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