First time tax payer? Here is what you need to know about ELSS

Are you a first-time tax payer? You might be getting hassled by the process of TDS deduction, investments in tax saving schemes and might be thinking about getting your tax burden reduced. There is no way that you can evade tax and therefore, you should plan and explore ways to save taxes.

Remember that you only get a maximum deduction of upto Rs 1.50 Lakh in a year on the combined investments which qualify for Section 80C of The Income Tax Act 1961. The premiums paid for life insurance policies, repayment of principal amount of your home loan, investments in PPF, NSC, Equity Linked Saving Schemes, Tax saving FDs of bank and post office are some of the options which qualify for tax saving under Section 80C.

If you have just started earning and don’t have enough money to spare for investments, you should first calculate how much investment would nullify your tax, and only then decide the investment amount in tax saving schemes.

For the first time tax payer, the first investment any earning individual should have for tax saving is Equity Linked Saving Schemes which is also known as ELSS Funds. Equity Linked Saving Schemes invests a major part of their portfolio in stocks. This way you can not only invest regularly in the stock market without taking direct risks, but you can save on taxes as well.

Equity Linked Saving Scheme funds earn compounding interest, which means that the longer you keep investing in these funds, the more returns you make. There are numbers that further this case – For example, over 3 years and 5 years period, Equity Linked Saving Schemes have given over 13% and 15% returns respectively (Source: CRISIL – AMFI ELSS Fund performance Index).

For example, if you had invested Rs 10,000 every month in a fixed income bearing tax saving instrument for 5 years, your Rs 6 Lakhs will become approximately Rs 7.40 Lakhs (assuming 8% return). On the other hand, a monthly SIP of Rs 10,000 in a good performing Equity Linked Saving Schemes would enable the Rs 6 Lakhs to grow to approximately Rs 8.48 Lakhs (assuming 13% annualized returns).

As you can see in the above example, a good performing Equity Linked Saving Schemes can give you superior returns over fixed income bearing tax saving investments.

This is why it makes sense to start investing as soon as you start earning or become a first time tax payer. The other benefit of Equity Linked Saving Schemes, apart from the tax break and superior return is as follows –

• Lowest lock-in period – Equity Linked Saving Schemes comes with the lowest lock-in period of 3 years.
• Tax efficient returns – As a first time tax payer, you might ignore the impact of taxes on your returns from tax saving investments. For example, a tax saving fixed deposit scheme may give investors 7% interest per annum, but if the interest income is fully taxable, then the effective return for the investor is only around 4.9% (for investors in the highest tax bracket of 30%). Interest paid by most risk-free tax saving schemes eligible under Section 80C are taxed as per the income tax rate of the investor. On a post-tax basis, the inflation adjusted return from risk free fixed interest investments can be very low.
• Equity Linked Saving Schemes, on the other hand, provide the most efficient tax adjusted returns. From April 1, 2018 onwards capital gains of up to Rs 1 lakh in a year in ELSS equity funds will continue to be tax free. Capital gains in excess of Rs 1 lakh will be taxed at 10% only.
• Long term wealth creation potential – As the traditional tax saving investments like PPF, EPF and NSC are perceived to be less risky, there is a tendency among investors to hold these investments for long term for meeting their goals like retirement, children education and marriage or simply for creating wealth. However, Equity Linked Saving Schemes can be a better tax saving investment option for meeting your long term goals simply because its returns are higher than that of the returns of fixed income bearing tax saving investments.

Let us see how much wealth you can create in the long run assuming the various rate of returns in the long term –

(The above are assumed rates of return on few investment options)

From the above chart we can clearly see that Equity Linked Saving Schemes can be a very good choice if you want to meet your long term financial goals apart from saving taxes on your investments.

Therefore, if you are a first time tax payer, Equity Linked Saving Schemes can be one of the best tax saving investment option for 3 reasons- Least lock-in period, superior returns over fixed income bearing tax saving investments and wealth creation opportunity over the long investment period.