Are you looking for the double benefits of tax saving and wealth creation? Do you seek inflation-beating returns from your investment over the long term? You can invest in Equity-Linked Savings Scheme or ELSS, which qualifies for the Section 80C tax deduction up to Rs 1.5 lakh per annum. It invests mainly in equity investments and has a mandatory three year lock-in period. However, many people believe that recycling or redeeming ELSS just after the mandatory lock-in period and reinvesting the money helps save taxes. Should you recycle your ELSS to save tax?
How does ELSS Recycling work?
You can invest in ELSS to avail of the Section 80C tax benefit. However, your first year’s investment in the ELSS is eligible for redemption at the end of three years.
You redeem the ELSS units of the first year and reinvest the money in the ELSS in the fourth year to claim the income tax deduction. It is called ELSS recycling, and you don’t have to allocate fresh money towards your tax-saving investments.
Should you recycle your ELSS to save tax?
Many people believe that ELSS recycling is a smart way to save taxes. However, financial experts maintain that ELSS recycling harms long-term wealth creation.
For instance, you would have invested Rs 1.5 lakh in a financial year in the ELSS if you did not resort to recycling ELSS. However, by indulging in ELSS recycling, you are not bringing in new ELSS investments of Rs 1.5 lakh per year.
It means you are investing lesser amounts towards your long term financial goals and sacrificing the opportunity to create wealth. Suppose you invest Rs 10,000 every month in an ELSS through the systematic investment plan or SIP for ten years.
Let’s assume an annual rate of return of 12%. You have invested Rs 12 lakh to accumulate a corpus of Rs 23.23 lakh. It means a wealth creation of Rs 11.23 lakh. You can use the ClearTax SIP Calculator to do the necessary calculations.
If you resort to recycling ELSS over ten years, chances are you would not have invested Rs 12 lakh in ELSS for this time frame. It means you have lost an opportunity to create a wealth of around Rs 11 lakh assuming a return of 12% per year from the ELSS.
You can lose potential returns from ELSS if you redeem your investment after three years. For instance, you will lose the opportunity of earning higher returns from ELSS if you exit after the mandatory lock-in period when the stock markets are crashing. It helps to stay invested in ELSS even after the compulsory lock-in period if you want to maximise returns over time.
Invest in ELSS for wealth creation
You must invest in ELSS through the SIP to build wealth steadily over time. It helps you avoid the last-minute rush to save taxes as you effectively start tax planning at the beginning of the financial year.
However, do not look at ELSS as just an investment to save tax. It helps to invest in ELSS for its potential to offer inflation-beating returns over time. It would help if you viewed ELSS tax deduction as an additional benefit while your primary aim is to achieve your long-term financial goals.
You must resort to recycling ELSS only if you don’t have the money to invest in ELSS for the financial year. Moreover, a financial crisis may force you to go for ELSS recycling to save tax if you don’t have the money for additional investment. In a nutshell, you must look at ELSS as a tool to build wealth and not just as an investment to save tax.
For any clarifications/feedback on the topic, please contact the writer at cleyon.dsouza@cleartax.in
I write to make complicated financial topics, simple. Writing is my passion and I believe if you find the right words, it’s simple.
