Tax saving is an essential aspect of our financial lives, and managing taxes efficiently is an art. If mastered, it can resolve many of your financial challenges. When it comes to saving taxes, most of us wait until March because we habitually push everything to the last minute, just like school assignments. This procrastination often leads to choosing the wrong products, especially for new investors who may not have much knowledge about investments or tax-saving strategies.
Before making any decisions, consider one of the most popular tax-saving options: tax-saving mutual funds.
Mutual funds have become the top choice for investors aiming to achieve their financial goals.
What is ELSS?
ELSS stands for Equity Linked Savings Scheme, a category of mutual funds that helps in saving taxes. ELSS mutual funds offer the dual advantage of capital appreciation and tax savings under Section 80C of the Income Tax Act. They fall under the equity category (open-ended), meaning more than 65% of the money is invested in equity. You can save taxes of up to Rs. 46,800/- (considering a 30% tax bracket, including cess) under Section 80C. ELSS funds offer two investment options:
- Growth
- Dividend (including dividend reinvestment and dividend payout)
An individual is not liable to pay tax on dividends received from mutual funds if the amount is below Rs. 10 lakh. However, if the amount exceeds this limit, the investor has to pay 10% of the total earnings as tax during that year. On the flip side, the government has made it mandatory for companies and mutual fund houses to deduct taxes from the dividends distributed before disbursing them, under Section 115-O of the Income Tax Act, 1961.
Features of ELSS Mutual Funds
1. Lowest Lock-in Period
There are other tax-saving products available in the market, like PPF, NPS, or FDs, which have a lock-in period of more than 5 years. ELSS mutual fund is unique in offering tax benefits with a minimum lock-in of just 3 years.
2. Tax Saving
ELSS is a type of mutual fund that allows a deduction of up to Rs. 1.5 lakhs from total income under Section 80C.
3. Dividend and Growth Options
You can choose to invest in either the dividend or growth option, depending on your financial needs. In the growth option, the money is reinvested and continues to grow until you redeem it. In the dividend payout option, dividends are paid out periodically.
How Does an ELSS Fund Work?
ELSS or Equity Linked Savings Schemes are mutual funds that mainly invest in company shares, known as equities. These funds have a diversified portfolio, which means they invest in huge, medium, and small companies from different sectors. The objective is to increase wealth in the long run while offering tax deductions under Section 80C of the Income Tax Act. You can invest any amount, but tax benefits are available only up to ₹1.5 lakh per year. ELSS funds have a lock-in period of 3 years, during which you cannot withdraw your investments
Example of ELSS Investment
The Axis Long Term Equity Fund is one of the top ELSS mutual funds that has consistently delivered strong returns over the years. It primarily invests in high-quality companies with a proven track record, offering both growth potential and tax-saving benefits.
- Growth Option: If you invest Rs. 1.5 lakhs in the Axis Long Term Equity Fund under the growth option, your investment will continue to grow over time. You won’t receive any payouts during the investment period, but your returns will compound, potentially leading to significant wealth accumulation by the end of the lock-in period.
Dividend Option: Alternatively, if you choose the dividend payout option, you could receive periodic dividends from your investment. These dividends are tax-free up to Rs. 10 lakh, providing you with a steady income while still enjoying the benefits of tax savings.
How to Choose the Best ELSS Mutual Fund?
To select an ELSS fund, first determine your risk profile. If you are conservative, select funds with higher large-cap exposure. If you are willing to take more risk, select those funds that have a combination of mid- and small-cap stocks. Review the past performance of the fund for at least 5 years and check how it has fared in good times and bad. Assess the returns consistency instead of looking at the highest-performing year alone. Check the fund manager’s history to know his/her investment approach and success ratio. Compare the cost ratios between funds of comparable nature, as lower costs can boost your net returns. Finally, check whether the fund meets your financial objective, such as wealth creation, retirement planning, or just tax saving
Why Should You Invest in ELSS Tax Saving Mutual Funds?
ELSS funds give you the dual benefit of wealth creation and tax savings. They invest mainly in equities, which have the potential to generate higher returns over the long term compared to traditional tax-saving options. Under Section 80C* of the Income Tax Act, you can claim a deduction of up to ₹1.5 Lakh in a financial year. The lock-in period is just 3 years, which is the shortest among all tax-saving investment options. Additionally, you can remain invested even after the lock-in period for greater growth potential. With professional fund management and diversification, ELSS offers a smart way to save taxes and build wealth together.
Best ELSS Mutual Funds to Invest in 2025
In 2025, there are some ELSS mutual funds that are noteworthy for their sustained performance, excellent portfolio management, and capacity to generate competitive returns. That said, past performance is not necessarily indicative of future results. These schemes have shown fortitude in adverse market conditions.
Some of the best ELSS options to consider include funds with a balanced allocation between large-cap, mid-cap, and small-cap equities. These funds benefit from diversification, which helps reduce risk while aiming for long-term capital appreciation. Look for schemes that have achieved consistent annualised returns over the last 5 to 10 years and which are led by experienced fund managers.
When considering ELSS funds for 2025, pay attention to aspects like:
- 3-year and 5-year CAGR relative to benchmarks.
- Expense ratio, since lesser charges would enhance net returns.
- Fund size and liquidity.
- Portfolio diversification by sector and market cap.
- Consistency of returns across bull and bear markets.
ELSS is among the most appealing tax savings investment choices under Section 80C. It has a minimum lock-in period of 3 years and the possibility of higher growth through equity exposure. Staying invested until the lock-in period can increase wealth generation opportunities.
Taxation Rules of ELSS Funds
ELSS funds are governed by capital gains tax provisions for equity investments. If you sell your units post-3-year lock-in, the profit upto ₹1 lakh in a financial year is exempted from tax. Any profit beyond this amount is charged 10% as Long-Term Capital Gain (LTCG) without indexation advantage. Dividend income is also taxable in the hands of the investor according to their respective income tax slab.
Tax Benefits Offered by ELSS (Tax Saving Mutual Funds)
Investments in ELSS are eligible for tax deduction up to ₹1.5 Lakh in a year under Section 80C of the Income Tax Act. This could save your tax outgo and lower the tax burden. While tax benefits are a plus, ELSS also comes with the growth aspect of equity exposure and has the lowest lock-in period of 3 years among tax-saving products. Investors have the choice of either a lump sum or an SIP mode to make claims and accumulate money in the long run.
* Tax deductions under Section 80C are only applicable under the old tax regime.
Comparison of ELSS (Equity Linked Savings Scheme) with Other Tax-Saving Instruments
| Instrument | Lock-in Period | Risk Level | Return Potential | Tax Benefit (Section 80C) |
|---|---|---|---|---|
| ELSS | 3 years | Moderate to High | High (Market-linked) | Up to ₹1.5 lakh |
| PPF | 15 years | Low | Moderate (Fixed rate) | Up to ₹1.5 lakh |
| NSC | 5 years | Low | Moderate (Fixed rate) | Up to ₹1.5 lakh |
| 5-Year Tax-Saving FD | 5 years | Low | Low to Moderate | Up to ₹1.5 lakh |
| NPS (Tier I) | Till retirement | Moderate | Moderate to High | Up to ₹2 lakh (with 80CCD) |
How Should You Invest in an ELSS Fund?
- Decide whether to invest through a lump sum or a Systematic Investment Plan (SIP).
- Open a valid Demat or mutual fund account with KYC completed.
- Select an ELSS fund that matches your risk appetite and investment goal.
- Invest regularly and stay invested for more than the minimum lock-in period to benefit from market growth.
What Should You Consider Before Investing in ELSS?
Before you invest in ELSS, it is important to know your financial goals and the level of risk you are willing to take. ELSS funds invest mainly in the stock market, so their returns can fluctuate in the short term. However, over a long period, they have the potential to offer higher returns than traditional tax-saving options like fixed deposits or PPF. You should also consider the 3-year lock-in period, during which you cannot withdraw your investment. Look at the fund’s past performance, the expertise of the fund manager, and the consistency of returns across different market conditions. It is also wise to compare expense ratios, as lower costs can improve long-term returns. Remember, ELSS works best when you stay invested beyond the lock-in period to allow your money to grow with the market.
Advantages of ELSS Mutual Funds
Short Lock-in Period
ELSS mutual funds has a lock-in period of just 3 years, after which you can withdraw 100% of your investment.
Transparent Portfolio
The portfolio in which your money is invested is transparently available to all investors.
Flexible Investment Modes
ELSS provides the flexibility to invest via SIP (Systematic Investment Plan) or lump sum.
Competitive Returns
The returns generated by ELSS funds are often better than those of competing products. However, the comparison of ELSS with other products is depicted below.
No Maximum Investment Limit
There is no maximum limit for investment in ELSS. Even once your tax limit is exhausted, you can still invest in ELSS mutual funds; however, tax savings are capped at Rs. 46,800/- under Section 80C of the Income Tax Act, 1961.
Disadvantages of ELSS Mutual Funds
Equity Exposure
ELSS is an equity-linked investment, so it’s not suitable for conservative investors who want to avoid exposure to equity markets.
Tax on Long-Term Gains
The money you receive after the 3-year lock-in period will be taxable as per long-term capital gains tax.
No Guaranteed Returns
Like all mutual funds, ELSS does not guarantee returns.
Conclusion
In conclusion, ELSS mutual funds like the Axis Long Term Equity Fund offer a compelling mix of tax savings and potential for capital growth, making them an attractive option for those comfortable with some level of equity exposure.
While the shorter lock-in period and flexibility in investment modes add to its appeal, it’s important to consider your risk tolerance before investing. As with any financial decision, understanding the nuances of ELSS mutual funds and how it fits into your overall financial plan is crucial for making the most of this tax-saving option.
Frequently Asked Questions
An Equity Linked Savings Scheme (ELSS) is a type of equity mutual fund that offers tax benefits under Section 80C (applicable only in the old tax regime). It mainly invests in equity and also has a lock-in tenure of 3 years.
Investments in ELSS are eligible for tax deductions up to ₹1.5 lakh under Section 80C (applicable in the old tax regime only). It reduces taxable income while providing possible long-term capital growth through equity investment.
ELSS investments have a mandatory 3-year lock-in period. Within this time frame, you cannot withdraw your units, which helps in long-term investment discipline and enables compounding to work effectively.
No, ELSS is market-linked and has moderate to high risk. Though it carries the prospect of higher returns, the worth of investments can differ based on stock market performance.
You can claim deductions by investing in ELSS before the end of the financial year. At the time of filing your income tax return, you can claim it by providing proof of investment from your fund house.
No, ELSS investment has a lock-in period of 3 years from the date of investment. Pre-mature withdrawal is not allowed. Thus, it is one of the shortest lock-in tax-saving schemes.
Gains up to ₹1 lakh in a financial year are tax-free. Amount exceeding this is charged at 10% without indexation benefit under current tax regulations.
Not necessarily. The LTCG tax is comparatively low, and it is possible to generate greater long-term returns by remaining invested, which can outweigh the cost of tax.
ELSS is best for those who want tax savings, possible high returns, and a short lock-in period when compared to other Section 80C (only under the old tax regime) investments.
Post-retirement investors should invest in ELSS with caution, owing to market fluctuations, investing only spare money that they can invest for at least 3 years.
You can place a redemption request through your mutual fund account or distributor. The amount will be credited to your bank account linked to the investment.
Unlike regular mutual funds, ELSS offers tax benefits under Section 80C (applicable only in the old tax regime) and has a mandatory 3-year lock-in period, making it both an investment and a tax-saving tool.
