ELSS lock-in period: here’s all you need to know

If you talk about tax and mutual funds, you will inadvertently talk about Equity Linked Saving Scheme (ELSS). ELSS is a tax-saving mutual fund that allows you to reduce your taxable income by up to Rs 1.5 lakh annually under section 80C of the Income Tax Act, 1961. Although ELSS is an open-ended fund, it comes with a lock-in period of three years. What is the ELSS lock-in period and how does it impact your returns, let’s find out.

What is ELSS Fund lock in period?

The term lock-in period in mutual funds refers to a specified duration during which investors like you are restricted from redeeming or withdrawing their investment. For every mutual fund, this period is predetermined and can vary depending on the type of scheme you choose to invest in. Some investors may find the concept of a lock-in period restrictive, especially in short investment horizons but it carries several important benefits for both investors and fund managers, especially in medium and long-term investments. This is why ELSS mutual fund lock in period is important to understand. Following are some reasons why ELSS investments lock in period are favourable for you –

Importance of ELSS mutual fund lock in period

ELSS fund lock in period can be favourable because of the following aspects –

·         Stability and long-term focus: The ELSS investments lock in period boosts stability and discourages impulsive decision-making, encouraging you to adopt a medium to long-term investment perspective, aligning with the fundamental principle of mutual funds as vehicles for wealth creation over time.

·         Fund stability and portfolio management: The lock in period provides fund managers a more stable investment pool, allowing them to manage the fund's portfolio effectively without factoring in the possibility of sudden redemption pressures or excessive portfolio turnover. This stability enables fund managers to make informed investment decisions and execute their investment strategies more efficiently.

·         Investor discipline: The lock in period makes you more disciplined in your investment approach and reduces the possibility and risk of knee-jerk reactions based on short-term market volatility. It encourages patience, helps investors ride out market fluctuations, and prevents them from making hasty decisions that may harm their long-term investment objectives.

·         Evaluation of fund performance: The lock in offers a meaningful timeframe for evaluating the performance of a mutual fund, enabling you to assess the fund's performance over a reasonable duration, taking into account market cycles and potential fluctuations. Accordingly, you can make informed decisions about continuing or redeeming your investment post the expiry of the lock in.

Let us continue with the other important considerations –

ELSS lock-in period: The shortest of all

Several investments under section 80C will help you save tax. However, all of them have a lock-in period. This means you cannot withdraw your investments before the end of the specified tenure. Investments like Public Provident Fund (PPF) and Unit Linked Insurance Plan (ULIP) have a lock-in period of 15 years and five years respectively. But ELSS has the shortest lock-in period of three years. Thus, it offers the highest liquidity as compared to others.

ELSS lock-in period: Lump sum vs Systematic Investment Plan (SIP)

Much like other mutual fund schemes, ELSS allows you to make a lump sum investment or invest through SIPs. Let’s understand how the three-year lock-in period works in both cases.

• Lump sum investment

The calculations are simple with lump sum investments. Say, you invested Rs 1,50,000 in ELSS on the 1^st of January 2022 and were allotted 150 units. In this case, you can sell all your units after the 1^st of January 2025.

• Investment through SIPs

SIPs allow you to break down your total investment amount into smaller investments. Once you start an SIP, a fixed amount is deducted from your bank account at fixed intervals and is invested in the mutual fund scheme of your choice. Every time the SIP amount gets credited to the scheme’s bank account, a certain number of units are allotted to you. The lock-in period applies to each SIP instalment. Thus, you can’t redeem all your units at once.

Example for better understanding

ELSS lock-in period: Advantages offered  

The three-year lock-in period helps you in the following ways.

• High returns

ELSS is an equity-linked mutual fund. Equities may be characterised by volatility, but they have the potential to deliver inflation-beating returns in the long run. Thus, the long three-year lock-in period can help you earn better returns. There is no automatic redemption in the case of ELSS post the lock-in period. So, you can stay invested in the fund for as long as you wish and gain from the power of compounding.

• Tax efficiency

Since ELSS is an equity fund that requires you to stay invested for three years, the gains on redemption will be treated as long-term capital gains. Long-term gains up to Rs 1 lakh/year are tax-free. Only gains exceeding Rs 1 lakh/year will be subject to a 10% long-term capital gains tax. On the other hand, short-term capital gains are taxed at 15%. So, the three-year lock-in period automatically makes ELSS more tax-efficient.

ELSS lock-in period: Other important aspects

1. The lock-in period applies even if you do not claim tax benefits for your ELSS investment.
2. You cannot pledge your ELSS units and avail of loans against them before the end of the lock-in period.

To sum it up

ELSS is a tax-saving mutual fund with the shortest lock-in period of three years. The lock-in period not only encourages you to tap into the potential of equity and build wealth but also makes your investment more tax-efficient.

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