Equity-linked savings scheme (ELSS) is the only kind of mutual funds covered under Section 80C of the Income Tax Act, 1961. Taxpayers can avail a maximum deduction of Rs 1,50,000 a year by investing in ELSS. It is one of the few equity-linked schemes that offer tax deductions.
ELSS comes with a lock-in period of three years, which is the shortest among all Section 80C options. It allows investing through lump sum and systematic investment plan (SIP). ELSS has the potential to offer returns as high as 15 percent a year. ELSS is the only tax-saving option which can provide inflation-beating returns.
An unplanned exit from any investment is a costly affair. Moreover, if you are exiting from a tax-saving investment, then you should consider investing in other tax-saving investment options. Also, in some investment options, if you exit within a specified period, then you would be liable to pay exit loads or penalties on the returns earned. Hence, be it any investment (regardless of tax-saving or not), it is inevitable that you plan your exit well in advance. If not, then you would suffer losses in various ways. Also, ELSS investors are not allowed to withdraw their investment within the lock-in period of three years.
Here’s why unplanned exit from the tax-saving fund is a bad idea:
1) ELSS is much more than a tax-saving option
ELSS is an equity-linked mutual fund. It is structured similar to any other equity fund. The portfolio allocation is predominantly towards the equity shares of companies of different market capitalisations. ELSS offers excellent and consistent returns in the long run. If you make an unplanned exit right after the lock-in period ends, then you would miss out on a chance to enjoy high returns.
2) You run the risk of not saving taxes
If your only tax-saving investment is in tax-saving mutual funds through SIPs, then an unplanned stoppage of SIP would expose you to tax liability. Moreover, if you stop your SIP towards the fag end of the financial year and have not made enough tax-saving investments, then you inevitably pay taxes as you won’t have enough time to make other tax-saving investments. Even if you make an investment that offers tax deductions, you wouldn’t have had enough time to analyse and compare various options available, thus missing out on choosing the best option.
3) Missing out on the benefit of rupee cost averaging
The primary advantage of investing with a long-term horizon is that you get the benefit of rupee-cost of averaging. If the markets are down and you exit, then you would miss out on a chance to buy more fund units. The best time to enter a mutual fund scheme or purchase more fund units is when the markets are down. This is because you can buy more units at a lower cost. You get the benefit of this when the markets shoot up. You can redeem your fund units at a much higher price.
4) You miss out on a chance to earn a regular income
If you are making an unplanned exit (after the lock-in period of three years is completed) from mutual funds, then you will probably make a one-time redemption. By doing this, you miss out on a chance to redeem your investment through a systematic withdrawal plan (SWP). With an SWP, you can withdraw a fixed sum regularly. The frequency of your withdrawal can be monthly, quarterly, bi-annually, or annually. Also, redemption through SWP is known to be tax-efficient.
Since you have invested in ELSS, which is the best tax-saving tool, you should make sure that you stay invested for a long time. Anyway, no ELSS investor is allowed to redeem their fund units within the lock-in period of 3 years. Once the lock-in period ends, it’s a good idea to continue staying invested for a long-term as it offers good returns.
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Archit Gupta is the founder and CEO of ClearTax.