Evaluating the benefits of Tax Saver Funds

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Investors look at two ways for calculating returns when it comes to any investment – value appreciation and tax saved. If an investment offers a way to save tax on income, while generating real returns, it is likely to be popular as an investment option, especially amongst salaried. This is one of the prime reasons why investment options such as NPS, Unit linked Insurance Plans (commonly known as ULIPs) and Tax saving Mutual Funds, also known as Equity Linked Savings Scheme (ELSS) is popular among a majority of investors.

ELSS is among the most commonly recommended tax-saving instruments for salaried individuals. New investors often use it as a good starting point. Due to the tax benefit offered, they are a preferred option for those looking to save tax on income of up to Rs. 1.5 lakhs per annum, while looking at generating returns linked to the equity market.

What are ELSS Funds?

ELSS as the name implies, is a category of Mutual Funds, which primarily invest in the equity market and at the same time helps investor in availing deductions under section 80C of the Income Tax Act, 1961 of up to Rs. 1.5 lakhs from the annual income. Due to this feature, these funds are also popularly called as Tax Saving Funds. A tax saver fund should invest at least 80% of its corpus in equities and equity-related instruments to qualify for this category. Like most other equity linked funds, you can invest this amount in the fund as either monthly or quarterly contribution (SIP) or as a lump sum investment.

Why invest in ELSS?

Lowest lock-in period: ELSS has the lowest lock-in period of 3 years as compared to other options like 5 year Fixed Deposits, 7 year National Savings Certificate, National Pension Scheme, etc. which fall under the same category of tax-saving instruments. Investors can invest up to Rs. 1,50,000 under section 80C to avail tax deduction on the invested amount. However, this limit is under the overall limit of section 80C and includes other investment options such as Fixed Deposits, Public Provident Fund (PPF), Employee Provident Fund (EPF), Insurance, ULIPs, etc. Although investors are free to invest more than Rs. 1,50,000 into such funds, the tax benefit will only be availed for the Rs. 1,50,000 limit.
Higher return potential: Due to the bulk of its investments being focused on the equity market, ELSS has the potential to earn the highest returns over long-term (typically, 5 years+) among all tax saving investment options currently available. While this does not necessarily exclude the possibility of varying returns or even the fund losing money due to market volatility, most funds have historically delivered returns that are better than debt funds and fixed deposits in the 3 to 5 year period.
Rupee cost averaging: The advantage of these funds lies in the fact that being a Mutual Fund, in times of lower NAV, more units are purchased if the investor is opting for SIP, thereby reducing the overall price of investment.
Taxation: ELSS gains are taxable at the time of redemption as Long Term Capital Gains (LTCG), the rate of tax is 10% plus applicable surcharge and cess depending upon the residential status and category of unitholder. Dividends paid by these funds are also taxable as per respective slab rate applicable to unitholder. The principal amount (with minimum lock-in period of 3 years) invested in ELSS would be allowed as deduction from taxable income. However, investors are free to hold onto to the fund even after the lock-in period is over. Therefore, while calculating returns on the funds, it is important to calculate returns as a combination of tax saved and net gains less the tax paid on gains.

Recap

ELSS funds represent one of the tax-saving instruments that could provide relatively higher returns compared to peers along with lowest lock-in period, and should be considered by investors to the maximum extent permitted under the tax laws in order to reduce tax outgo. Overall returns should be considered after keeping in mind the total of tax saved and returns obtained. Investors of course are free to invest more if they wish, with the provision that the tax-saving aspect is removed. For those investing in these funds, holding on to these investments beyond the mandatory three year lock-in period usually delivers incremental gains in returns.

Some of the recommended ELSS funds by Kotak are:

ELSS Funds	AUM (in crs)	CAGR (%)
ELSS Funds	AUM (in crs)	1Y	2Y	3Y	5Y
DSP ELSS Tax Saver Fund	13,583.00	30.07	16.59	22.48	19.39
Kotak ELSS Tax Saver Fund	4,691.21	23.69	15.01	20.80	17.94
Mirae Asset ELSS Tax Saver Fund	20,430.78	27.11	12.82	19.88	19.01
Source: MFI Explorer \| Data as on 31st December 2023.

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Kotak Mahindra Bank Limited, AMFI Registered Mutual Fund Distributor. AMFI Registration Number (ARN) 1390.

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Disclaimer: This Article is for information purpose only. The views expressed in this Article do not necessarily constitute the views of Kotak Mahindra Bank Ltd. (“Bank”) or its employees. Bank make no warranty of any kind with respect to the completeness or accuracy of the material and articles contained in this Newsletter. The information contained in this Article is sourced from empaneled external experts for the benefit of the customers and it does not constitute legal advice from Kotak. Kotak, its directors, employees and the contributors shall not be responsible or liable for any damage or loss resulting from or arising due to reliance on or use of any information contained herein.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

Evaluating the benefits of Tax Saver Funds

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