Under the section 80C of Income Tax Act, 1961, every income earner is eligible for tax deduction by lowering his or her tax liability. But among all the tax-saving tools mentioned in the section, advisors consider Equity Linked Savings Scheme (ELSS) as the most effective avenue to lower your tax burden. Under this instrument, you can actually claim a deduction in tax amount of up to ₹1.5 lakh every year. By investing ₹1.5 lakh recurrently for the first 3 years of the lock-in-term you can convert this scheme into a successful tax-saving tool.
If you want to know why you should choose this investment policy and not any other instrument, then here is your answer. ELSS addresses the predominant issue of lack of financial liquidity such as if you have any financial emergency or some other important goals to fix first. In simpler words, ELSS eliminates the compulsion of incremental investment of ₹ 1.5 lakh year after year to avail the tax discount because once your lock-in-period is over (which is 3 here), you can reinvest that same amount that you have accumulated in these three years i.e. ₹4.5 lakh. Thus, you can now fully focus on meeting your other essential financial ends while availing the tax benefits at the same time.
Let me show you an example which would explain this aforementioned fact more clearly.
Assume that in the financial year (FY) 2018-19, you choose an ELSS for an amount of ₹1.5 lakh and for the period of 3 years. After the expiry of its term which is 2021-22, you can withdraw this amount. Again, in the FY 2019-20, you invest a same amount for the same lock-in term which automatically matures and can be withdrawn in the FY 2022-23 and so forth. Subsequently, the investment done in FY 2020-21 under the same policy would be ready for withdrawal in the FY 2023-24. To conclude, all through the entire process of three years the total amount accumulated by you in your ELSS account for investment is ₹4.5 lakh which makes you eligible for a tax deduction for these three consequent years.
But the trick here is by spending ₹4.5 lakh in 3 years, you will create a fund loop where this amount gets recycled year after another, thus freeing you from the burden of investing again and again. The investment done in FY 2018-19 will mature in the FY 2021-22 which you reinvest in the same year and so on. This way, you keep availing tax discounts every year without spending any extra bucks. But one thing to remember in this procedure is that to qualify for Long Term Capital Gain (LTCG) tax of 10%, you might need to keep adjusting the amount whenever there is a deficit.
To help you comprehend this idea more precisely, a tabular illustration of the investment and tax analysis has been depicted below. This realistic example shows NAV and Tax Deducted of an ELSS from FY 2012-13.
From the above table, it is quite clear that you will start acquiring the tax benefits from the FY 2016-17 onwards without investing any longer. The amount invested in the financial years 2013-14, 2014-15, and 2015-16, gets reinvested after you redeem it and make it available for reinvestment. At this moment, your mind might be acquired by the query – what if the balance value falls short of the amount required to claim for the deduction (i.e. when it is < ₹1.5 lakh)? In such instances, you get the chance to invest that extra amount that your balance value is lacking in order to qualify for the levy deduction. However, the case shown here in the table states that you already have a surplus of the amount you actually need for availing the tax advantage.