How the Lock-in Period in ELSS Funds Helps You Save on Taxes

Introduction

Equity Linked Saving Scheme (ELSS) is a popular investment option known for its tax-saving benefits. Under the Income Tax Act, investors can avail of a tax deduction of up to Rs. 1.5 lakh through this long-term mutual fund. However, it comes with a mandatory lock-in period of 3 years.

The lock-in period signifies that you cannot withdraw your invested amount until the completion of three years. Once the lock-in period ends, you have the flexibility to either re-invest or redeem the units based on your financial goals. Below, you will find more details about the ELSS lock-in period.

Method of Investing and Lock-in Period

 

There are two methods for investing in an ELSS fund:

1. Lump-Sum Investment

When you invest a lump sum in an ELSS fund, the lock-in period starts from the day of purchase. For example, if you buy ELSS units on January 01, 2021, you cannot sell them until January 01, 2024, regardless of any urgency you might face.

2. Systematic Investment Plan (SIP)

A Systematic Investment Plan (SIP) allows you to invest smaller amounts in ELSS funds at regular intervals. You decide the investment amount and the frequency of your contributions.

Once you set up the debit mandate with your bank, the SIP operates automatically, purchasing units at the NAV on the debit date. The lock-in period for SIP investments is treated differently. Each SIP installment has its own 3-year lock-in period starting from the date of investment. 

What Does the Lock-in Period Mean in ELSS?

Lock-in periods are the durations during which you cannot redeem your purchased units. For ELSS funds, this period is three years. However, ELSS is not the only tax-saving investment with a lock-in period. Check out the table below to see which investments have the shortest lock-in periods: 

 

The lock-in period of ELSS funds encourages investors to adopt a long-term investment approach, enabling fund managers to manage the portfolio more effectively without the pressure of frequent redemptions. 

How Does the 3-Year Lock-in Period Work?

ELSS investments feature the shortest lock-in period of 3 years among all Section 80C eligible investment options. During this time, you are prohibited from liquidating your investments, making ELSS the minimum lock-in period compared to other tax-saving instruments.

Throughout the lock-in period, ELSS funds cannot be redeemed or pledged before the 3-year holding period is completed from the date of investment. Additionally, you cannot take loans against ELSS units during this lock-in period.

Lock-in Period for SIP Investments

Each SIP installment in ELSS is individually subjected to a distinct 3-year lock-in period. It starts from the date of investment for each installment, not from the SIP registration date. Therefore, every SIP installment is treated as a distinct lump sum investment for lock-in purposes.

The 3-year lock-in period is a standard feature of ELSS, regardless of whether the investor has claimed tax benefits. This helps investors avoid the temptation to redeem their investments during market downturns, which can be detrimental to long-term financial goals.

Unlike other Section 80C investment options, ELSS funds require investors to decide whether to redeem or continue holding them at the end of the lock-in period. Investors have the option to continue holding their ELSS investments beyond the lock-in period and must specifically request redemption if they wish to liquidate their holdings.

Tax Benefits of ELSS Funds

ELSS funds provide tax deduction benefits under Section 80C of the Income Tax Act, 1961. Investors are eligible for a tax deduction of up to Rs. 1.5 lakh annually by investing in ELSS funds, potentially saving up to Rs. 46,800 per financial year. It's important to note that the Rs. 1.5 lakh deduction limit is cumulative across all investments eligible under Section 80C.

Investments in ELSS funds qualify for long-term capital gains (LTCG) taxation due to the mandatory 3-year lock-in period. Currently, LTCG up to Rs. 1 lakh in a financial year is exempt from tax. Dividends received from ELSS funds are taxable based on applicable Income Tax slabs. 

Post Lock-in Period: What to Do Next?

After the mandatory 3-year lock-in period ends, you are not required to immediately redeem your units. The ELSS fund transforms into a diversified, open-ended equity scheme, providing you with the flexibility to redeem units whenever you wish.

For investments made through SIPs, the lock-in period applies individually to each installment based on its respective investment date or SIP initiation date.

 Conclusion

The lock-in period of ELSS funds is essential in fostering disciplined investment habits among investors. By enforcing a mandatory holding period, ELSS funds discourage impulsive withdrawals and promote a steadfast, long-term investment approach. This discipline not only mitigates the pitfalls of emotional investing but also cultivates a habit of strategic financial planning.

Investing in ELSS funds with a 3-year lock-in period encourages investors to focus on their long-term financial objectives rather than short-term market fluctuations. This approach not only aids in wealth accumulation but also enhances the likelihood of achieving sustained financial goals. Therefore, ELSS funds, with their benefits and relatively short lock-in period, present a compelling option for investors seeking to build wealth and secure their financial future over the long term.

 

Frequently Asked Questions

1. Can I withdraw my investments before the lock-in period ends?

No, investors are not allowed to withdraw their investments until the three-year lock-in period has been completed.

 

2. Do ELSS funds offer any tax benefits?

Yes, ELSS funds offer tax benefits. By investing in ELSS funds, investors can claim deductions of up to Rs. one and a half lakh per year from their taxable income.

 

3. Can I invest in ELSS funds through SIP?

Yes, many ELSS funds offer the option of Systematic Investment Plans (SIPs). This allows investors to regularly invest smaller amounts at scheduled intervals, making it a convenient and affordable way to invest in mutual funds.

 

4. Do I need to redeem my units once the lock-in period of my ELSS is over?

It is not mandatory to redeem your ELSS units once the lock-in period expires. Investors have the flexibility to choose whether to redeem or continue holding based on their financial goals and the fund's performance.

 

5. What happens to my ELSS if I choose not to redeem it after the lock-in period?

After the lock-in period ends, the ELSS fund transitions into a regular open-ended equity scheme. Investors can continue to hold their investments and redeem them at any time based on their preferences and financial needs.

 

Disclaimer: This blog is dedicated exclusively for educational purposes. Please note that the securities and investments mentioned here are provided for informative purposes only and should not be construed as recommendations. Kindly ensure thorough research prior to making any investment decisions. Participation in the securities market carries inherent risks, and it's important to carefully review all associated documents before committing to investments. Please be aware that the attainment of investment objectives is not guaranteed. It's important to note that the past performance of securities and instruments does not reliably predict future performance.