What is the ELSS Lock in Period? Learn Meaning, Benefits & Calculation
In the realm of tax benefits and incentives provided by the Income Tax laws, Section 80C stands out as a widely utilized avenue. This section allows taxpayers a deduction of up to Rs. 1.50 lakh from their taxable income. Eligible payments and investments, including contributions to instruments like Public Provident Fund (PPF), Statutory Provident Fund (SPF), Life Insurance Premiums, housing loan repayments, and 5-year tax-saver fixed deposits, qualify for this deduction.
Equity Linked Savings Scheme (ELSS) is a notable inclusion in Section 80C. These schemes allocate a minimum of 80% of their net assets to equities and equity-related investments, featuring a mandatory lock-in period of 3 years for investors. This article will go into more detail about what this lock in period entails . Follow along to know more!
What is the ELSS Lock in Period?
Financial instruments like ELSS funds, tax-saving Fixed Deposits, close-ended mutual funds, hedge funds, and PPF often have lock-in periods, restricting investors from selling their investments for a specific duration. Mutual funds, especially close-ended ones, typically enforce a 3 to 5-year lock-in period, restricting both entry and exit. This limitation aims to discourage seeking short-term gains with higher returns, emphasizing a long-term investment approach. Once the lock-in period concludes, investors regain the ability to liquidate or sell their investments.
How Does the ELSS Lock in Period Work?
ELSS funds offer the shortest lock-in period of 3 years among Section 80C-eligible investments. This means investors are restricted from liquidating their holdings for a minimal duration compared to other tax-saving options. Throughout the lock-in period, investors cannot liquidate their ELSS fund investments before completing the 3-year holding period from the investment date. Additionally, pledging these units as security for loans is prohibited during this time.
For lock in period of SIP investments, the 3-year lock-in is calculated separately for each installment, not from the SIP registration date. Each SIP installment is treated as an independent lumpsum investment in terms of the ELSS tax saver mutual fund lock in period. Importantly, the 3-year lock-in is a fundamental characteristic of ELSS mutual funds, independent of availing tax benefits. This feature helps investors resist the urge to redeem investments during market downturns, promoting a more strategic approach.
Unlike many Section 80C-eligible options automatically liquidated after the specified tenure, ELSS funds don’t automatically redeem upon the 3-year lock-in expiry. Investors retain flexibility, needing to make a specific redemption request to liquidate their ELSS investments. Considering the advantages, including the brief ELSS fund lock in period and discussed benefits, investors may find ELSS funds attractive for financial goals extending beyond three years. Holding onto investments for a more extended period can contribute to wealth creation and goal achievement. Let us now explore the ELSS lock in period calculation.
How to Calculate the ELSS Lock in Period?
The lock in period for a lump-sum investment in mutual funds concludes three years from the investment date. For instance, if 30 units were bought at NAV Rs. 250, with an investment of Rs. 30,000 on 1st Mar 2017, redemption can be done after 1st March 2020.
In the case of SIP lock in period in ELSS funds, the tax saving mutual funds lock in period ends three years after each SIP installment. Whether monthly or quarterly, every SIP installment must undergo a three-year ELSS mutual fund lock in period.
For example, let’s consider a monthly SIP of Rs. 3,000 starting from 10th June 2018, purchasing units based on the NAV:
- 10th June 2018: 40 units
- 10th July 2018: 35 units
- 10th Aug 2018: 42 units, and so forth.
Redemption dates for the above investment would be:
- 10th June 2021: 40 units
- 10th July 2021: 35 units
- 10th Aug 2021: 42 units
Tax Benefits of ELSS
ELSS funds provide tax benefits under Section 80C of the Income Tax Act, 1961. Investors can annually claim a deduction of up to Rs.1.5 lakh, resulting in potential tax savings of Rs.46,800. It’s crucial to note that the Rs.1.5 lakh deduction applies to all Section 80C fund investments.
The returns from ELSS fund investments qualify as long-term capital gains (LTCG) due to a mandatory three-year lock-in period. Current tax regulations exempt LTCG up to Rs.1 lakh in a financial year from taxation. Dividends received are taxable based on applicable Income Tax slabs.
What To Do After the ELSS Lock in Period End?
After the lock-in period ends, you’re not obligated to withdraw your investment. You can explore the fund’s past performance, factor in market dynamics, and compare it with other ELSS mutual funds. You can consider reinvesting the redeemed amount for additional tax benefits. ELSS funds offer flexibility, allowing investors to withdraw anytime. If there’s no urgent need for an emergency fund, a 5-10 year investment in ELSS funds is poised for favorable returns.
ELSS Lock in Period As Per Methods of Investment
There are two ways to invest in an ELSS fund:
Lump-Sum
When you invest a lump sum, the lock-in period begins from the purchase date. For instance, if you buy ELSS fund units on January 01, 2021, you can’t sell them until January 01, 2024, regardless of any urgency.
SIP (Systematic Investment Plan)
- SIP enables you to invest in ELSS fund units by regularly putting in smaller amounts.
- You decide the investment amount and the frequency.
- After setting up a debit mandate with your bank, SIP automatically initiates, purchasing units at the NAV on the debit date.
Check out our example above on how the ELSS SIP lock in periods work.
Why is the ELSS Lock in Period Important?
The lock-in period is crucial for investors and mutual funds alike. Holding onto mutual fund investments for the long term is key to maximizing benefits through capital appreciation. In the case of ELSS, investors also enjoy tax benefits.
This lock-in period ensures stability in mutual funds, preventing liquidity issues that can arise from excessive selling. By limiting frequent withdrawals, investors can maximize their returns.
Benefits of the ELSS Lock in Period
ELSS funds stand out as a prime choice for securing tax benefits under Section 80C. The mandatory three-year lock-in not only cultivates patience but also fosters a conducive environment for long-term wealth growth.
Key advantages of opting for ELSS funds due to the lock-in period include:
- Patience Pays Off: The lock-in period encourages investors to embrace a long-term perspective, promoting sustained investment. This patient approach has the potential to yield higher returns.
- Wealth Generation: ELSS funds, rooted in equity investments, historically showcase superior long-term performance. Committed adherence to the lock-in duration enhances the likelihood of wealth accumulation.
- Tax Efficiency: ELSS funds offer tax benefits under Section 80C, allowing deductions for investments up to Rs. 1.5 lakh. It’s crucial to note that any investments exceeding this threshold are not eligible for deductions. Additionally, gains surpassing Rs. 1 lakh upon redemption post-lock-in attract a 10% long-term capital gains tax.
- Volatility Shield: The lock-in period acts as a safeguard against impulsive trading decisions triggered by short-term market fluctuations. This fosters a disciplined investment approach by discouraging frequent buying and selling of fund units.
In essence, ELSS funds, with their tax advantages and lock-in period dynamics, offer investors a strategic avenue for disciplined, patient, and potentially rewarding long-term wealth creation.
Exceptions and Considerations for ELSS Lock in Period
Two important considerations regarding investment lock-in periods:
- Exceptions to the lock-in period may apply in specific circumstances, such as the death of the investor or instances of severe illness or disability.
- Switching between schemes within the same fund or choosing dividend reinvestment does not alter the lock-in period. The initial investment remains subject to the three-year lock-in period.
To Wrap It Up…
The ELSS lock-in period serves as an optimal solution for those aiming at tax savings and wealth growth. By investing in ELSS, you can trim down your taxes by up to Rs. 1,50,000 in a fiscal year, all while having the potential for superior returns compared to other similar investments. Notably, ELSS features the shortest lock-in period among tax-saving options, providing the flexibility to stay invested for a longer duration if desired.
Embarking on your ELSS investment journey involves exploring options and selecting funds based on their performance history. By scrutinizing their past performance, you can make well-informed decisions, aligning your investments with your financial objectives. Seize the advantages offered by ELSS and kickstart your investment in this tax-saving avenue today.
FAQs
Investing in ELSS funds involves a three-year lock-in period, limiting the realization of short-term capital gains. Instead, investors can capitalize on tax-free long-term gains, capped at Rs 1 lakh annually. Any gains exceeding this limit are subject to a 10% long-term capital gains tax.
ELSS funds require a three-year 80c mutual fund lock in period. After this period, whether it’s an installment or lump sum, the ELSS becomes a fully liquid, open-ended equity investment.
After holding ELSS for three years, investors can withdraw by redeeming units. They have the option to reinvest the withdrawal in the same or different funds to retain tax exemption for the year.
Regrettably, ELSS investments cannot be withdrawn before the mandatory three-year ELSS scheme lock in period. Unlike some funds that permit loans against securities, ELSS funds do not offer this option.
ELSS funds invest mainly in equity and related instruments, exposing investors to risks similar to those in stock investments.However, not all ELSS funds are inherently high risk schemes.
Open-ended debt, hybrid, and equity mutual funds lack a lock-in period and may offer SIP without lock in period, as well. However, this is except for ELSS schemes in the equity category. You have the flexibility to sell these mutual funds anytime without restrictions on timing or duration, offering freedom in managing your investments.
