Has ELSS lost its charm?
The Budget is over and the one change that might have caught your attention is the introduction of the long term capital gains tax on equity and equity related products. The new LTCG tax on equity is at 10% of the profits above Rs. 1 lakh. So the first Rs. 1 lakh profit is still tax free.
An investment of upto Rs.1,50,000 in ELSS funds (and other Section 80C investments) will continue to be deductible from your taxable income. But ELSS funds are mutual funds that invest in equities and hence gains from them will now be taxed. Does this mean that ELSS funds are no longer a good option for your tax saving? Let’s do a quick calculation to find out.
Case 1: Assume that you don’t have any equity investments other than ELSS. This means that any profits that you make in your ELSS funds will be taxed only if they exceed Rs. 1,00,000.
| Return Assumed (p.a.) | Investment (Rs) | Value at the end of 3 years (Rs) | Profit (Rs) | Profit after exemption of Rs.1,00,000 | Tax (Rs) (at 10%) | Effective returns (p.a.) |
| 10% | 1,50,000 | 1,99,650 | 49,650 | 0 | 0 | 10% |
| 12% | 1,50,000 | 2,10,739 | 60,739 | 0 | 0 | 12% |
| 15% | 1,50,000 | 2,28,131 | 78,131 | 0 | 0 | 15% |
| 18% | 1,50,000 | 2,46,455 | 96,455 | 0 | 0 | 18% |
| 20% | 1,50,000 | 2,59,200 | 1,09,200 | 9,200 | 920 | 19.86% |
If you were to sell your investments at the end of the 3 year lock in period, your profit will not go beyond Rs. 1 lakh unless you make a killing of more than 18% per annum return for those three years. For that kind of return, you should not mind shelling out some tax.
Case 2: Assume that you have other equity investments and that you book profits in excess of Rs.1,00,000 from these other investments. This means that any profits that you make in your ELSS funds will now be taxed at 10%.
| Return Assumed (p.a.) | Investment (Rs) | Value at the end of 3 years (Rs) | Profit (Rs) | Tax (Rs) (at 10%) |
Profit after tax (Rs) | Effective returns (p.a.) |
| 10% | 1,50,000 | 1,99,650 | 49,650 | 4,965 | 44,685 | 9.08% |
| 12% | 1,50,000 | 2,10,739 | 60,739 | 6,074 | 54,665 | 10.91% |
| 15% | 1,50,000 | 2,28,131 | 78,131 | 7,813 | 70,318 | 13.67% |
| 18% | 1,50,000 | 2,46,455 | 96,455 | 9,645 | 86,809 | 16.44% |
| 20% | 1,50,000 | 2,59,200 | 1,09,200 | 10,920 | 98,280 | 18.29% |
Historically, ELSS funds have given double digit returns. Even when we assume a relatively low return of 10% p.a., the post tax return would be 9.08%. This is higher than the returns from most other investment options available under Section 80 C. Equity investments always come with some risk but for those willing to take the risk in expectation of a higher return, the post-tax returns in ELSS funds can still be very good.
In both cases above, we are assuming that you would sell your investments at the end of the 3 year lock-in period. Does this mean that we think you should do it too? Not really. But it might be a good idea to sell and book profits to the extent of the Rs. 1 lakh exemption amount. That way, you can avoid accumulating a larger profit which can be taxed when you sell the investment at a later stage. Irrespective of the tax implications, you can also use these three year cycles to switch out from under performing funds to funds which may perform better in the future. Of course, if you choose to sell the investment at the end of three years, it is important that you reinvest the money to build wealth over the long term.
