ELSS – One Investment, Two Goals – Tax Saving, Retirement Planning
Unlike other saving schemes like Fixed Deposit (FD), Public Provident Fund (PPF) and National Savings Certificate (NSC), Equity-Linked Savings Scheme (ELSS) offer the shortest lock-in period with a higher return on investment. For the majority of earning citizens of India, retirement saving is one of the most ignored goals as it is distant and one does not feel a dire need to address it.
However, the desire to save tax could be help us to meet two goals – tax saving and retirement planning – with one single investment. Usually, investments leading to tax saving are done annually to save tax for that fiscal year. Under the Income Tax Act of India, section 80C allows maximum deduction of INR 150,000 from your total annual income. ELSS is one such instrument that let you claim these benefits. ELSS is riskier than those fixed income alternatives under section 80C, but it generates the higher rate of returns which are partially taxable as compared to the fully taxable returns from FDs and NSCs. ELSS is the best way to save tax and invest for retirement, especially for the young earners.
How to invest in ELSS
ELSS is an equity-linked savings scheme, which means the amount will be invested in equities and they need time to perform. As compared to investment schemes like FD, PPF, NSC, and NPS (National Pension Scheme) which usually have the lock-in period of 5 years, 15 years, 5 years, and till retirement respectively, ELSS has the shortest lock-in period of just 3 years.
After the lock-in period gets over, the scheme becomes an open-ended scheme and the funds invested become eligible to be withdrawn. However, it is advisable that instead of withdrawing the funds let them remain invested until about five years before you retire.
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Since equities are more volatile, any fresh investments and the ongoing open-ended investments in ELSS within 5-7 years of retirement must be considered only after assessing your risk profile. So here is how it will work. Say, you invest INR 8,000 monthly in ELSS for 25 years towards retirement. Expecting a long term rate of return as 15% per annum, the maturity amount will be somewhere close to INR 2.6 Crores, which could be a hefty amount in one’s retirement portfolio in addition to other investments made as part of retirement planning.
Now before you decide which scheme to invest in, you need to reach a conclusion as to how much you would want to save as your retirement benefit.
How much to save
You need to calculate an exact amount of post-retirement monthly needs and then start saving accordingly to avoid over/under-investing.
Here is how you can do that in 5 simple steps:
- Get hold of your present monthly expenses at current costs
- Get the number of years left for your retirement
- Inflate the present monthly expenses at around 5%. The amount you will get is the monthly expenses that you would likely to incur once you have retired after adjusting for inflation.
- Now estimate how much amount you need to meet your inflated monthly expenses.
- At the last step, you will have to find out how much monthly savings would you need to accumulate till retirement. There may be other savings too that you have planned, so consider them too.
How to choose ELSS
Selecting a single best ELSS is not an easy task. There is some ELSS that has more exposure to large-caps, while some perform better with mid-cap or multi-cap stocks. It’s found better to invest in not more than 2-3 diversified ELSS and ensure that they belong to different industries and market capitalizations.
How to save through ELSS
You can invest in ELSS through two of the way. One is depositing a lump sum amount into the chosen ELSS at regular intervals. The other way is to invest a fixed amount at regular intervals also called as SIP (Systematic Investment plan). By the latter way, you are not trying to capture the ups and downs of the market, but the cost of your investment will be scattered over a period of time. This is most preferable for the young earners.
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What’s your action after investing in ELSS?
You don’t have to worry about the ELSS during the lock-in period. However, once the lock-in period ends, you need to review the performance of the schemes you have invested in. If your ELSS is performing, there is no need to redeem it. One thing that you need to restrain yourself is being tempted from the fund’s return in isolation. Compare the scheme’s return with its benchmark return. Not a scheme which is consistently unable to cross its benchmark return should be in your investment portfolio. Also, observing the category average returns against its peers will give you an idea about how good/bad your investment is. There can be several reasons for that, and you need to explore all of them before deciding to switch on to others.