ELSS Withdrawal: Can You Redeem ELSS Before 3 Years?

Of the various savings schemes offering tax incentives under Section 80C of the Income Tax Act in India, the Equity Linked Savings Scheme (ELSS) is the most popular investment choice for tax deductions among taxpayers.By investing in ELSS , you can claim tax deductions of up to ₹1.5 lakhs a year. Plus, there is the potential for higher returns. However, the relatively short lock-in period that ELSS has is particularly attractive for taxpayers compared to many other investment instruments.Investments in most savings schemes are subject to mandatory lock-in periods of five years or more. For instance, schemes such as the National Savings Certificate (NSC), Senior Citizens Savings Scheme (SCSS), Life Insurance schemes, or even Fixed Deposits have lock-ins of five years; for Public Provident Fund (PPF), it is 15 years. Compared to this, the lock-in period for ELSS is just three years. Naturally, it appeals to many taxpayers.However, a crucial question arises: what if you need to withdraw funds before the lock-in period is over? Will premature withdrawal be allowed?This article addresses this question and provides a detailed overview of ELSS, including its benefits, risks, and much more. But first, let us understand what ELSS is.

An Equity Linked Savings Scheme (ELSS) is a type of Mutual Fund scheme that is mandated to invest at least 80% of its assets in equities. There are no regulations or rules on which sector or company size it invests in; that decision is left to fund managers (records show their preference seems to be large-cap companies).However, because ELSS funds invest primarily in the stock market , they do not offer any assured returns. As a result, the risk associated with investing in these funds is high.As stated earlier, ELSS funds have a relatively shorter lock-in period of three years as compared to most other savings schemes, during which withdrawals are not allowed. However, once the lock-in period ends, investors have the flexibility to redeem or switch investments.Apart from offering returns on their investments, ELSS also allows taxpayers to save up to ₹46,800 annually in taxes. Also, there is no entry or exit load.Also Read: How Does The 3 Year Lock-In Of ELSS Funds Work?

Like any Mutual Fund, ELSS funds are subject to market risks as they invest in market-linked instruments, which means their performance depends on the underlying securities. In other words, they offer no guaranteed returns.However, what the three-year lock-in does is that it enables ELSS investments to leverage the power of compounding. Coupled with the potential returns from equity, returns on ELSS investments can be rewarding.This means ELSS is ideal for those with a high-risk tolerance and long-term investment goals.

There are two main ways to invest in ELSS Fund, which is how you would invest in any Mutual Fund: either invest as a lump sum or Systematic Investment Plan (SIP) route.

Lump sum route

You invest a one-time lump sum amount into an ELSS scheme. You can decide whether to redeem all your fund units, maintain your investment, or partially redeem your investment after the three-year lock-in period.For example, if you make a lump sum investment of ₹1.5 lakhs on 1st April 2023, you can initiate a partial or full ELSS withdrawal after three yearson 1st April 2026.

SIP route

You invest a fixed amount at regular intervals, usually monthly. Each periodic investment in SIP has its own individual lock-in period of three years, during which ELSS SIP withdrawal is not permitted. This means that the lock-in period for each SIP instalment starts from the respective investment date, as per ELSS SIP withdrawal rules.Let us assume you invest ₹2,000 every month from January 2023 to May 2023 by the SIP method.

The lock-in period applies to each monthly investment individually, and investments cannot be redeemed until the complete three-year lock-in period is over.This means that the units earned with the various investments must be redeemed after the respective lock-in period ends. So, taking the chart above as a case study, if 40 units were earned on 1st January 2023, the redemption can be after 1st January 2026. Similarly, if 35 units were earned on 1st February 2023, these can be redeemed after 1st February 2026.The decision to withdraw your entire investment or stay invested is up to you. It is important to note that the specific process and requirements for ELSS withdrawal after three years may vary, depending on the Mutual Fund scheme you have invested in. Consult with your financial advisor for detailed instructions on withdrawals.Also Read: Working Of A Systematic Investment Plan

Withdrawing ELSS investments before the lock-in period is completed is not permitted. However, if the unitholder (investor) passes away before the lock-in elapses, the nominee can redeem the investment provided a year has passed since the units were allotted to the deceased investor.If a living investor makes a withdrawal before the three-year lock-in period is completed, the investor will not be penalised as such, but their tax benefits will be revoked. In other words, the investor will have to pay tax as per the applicable income tax slabs on any profits made during the invested period.Also, the amount withdrawn will be deemed taxable income in the year the withdrawal is made. Please note that loss of tax benefits can impact overall returns.Also Read: 5 Common Mistakes to avoid while Investing in ELSS

After the three-year period is complete, you can decide to withdraw the investment in the form of liquid money and reinvest it in another ELSS and reap the benefits. This is beneficial as you would not have to worry about locking any extra amount from savings/income, even while continuing to enjoy tax benefits.Also Read: How Much Returns Can I Expect In ELSS Mutual Funds?

There is no possibility of realising short-term capital gains with ELSS funds because of the three-year lock-in; any gains will have to be realised after this period and will be deemed long-term capital gains (LTCG). Such gains of up to ₹1 lakh are tax-free; any amount exceeding that is subject to a long-term capital gains tax at 10%, along with applicable cess and surcharge.Dividends received from ELSS investments are added to your overall income and taxed at your income tax slab rate.

Investing in ELSS spells a clutch of benefits, as listed below:

• First, you can claim deductions of up to ₹1.5 lakhs a year under Section 80C.
• Second, compared to other tax-saving options, its long-term returns are potentially higher.
• Third, the lock-in period of just three years is shorter than that of other schemes.
• Fourth, long-term capital gains up to ₹1 lakh are tax-exempt annually.
• Finally, ELSS offers an opportunity to benefit from the growth potential of different companies.

Also Read: Tax Saving Mutual Funds: ELSS Tax Saving Mutual Fund

Despite the benefits of ELSS investments, there are a few risks as well, which investors should consider, such as:

• Liquidity risk The three-year lock-in period limits access to invested funds during that time.
• Market risk ELSS funds invest in equities, exposing investments to market volatility and fluctuations, which can hurt returns.
• Performance risk The fund manager's decisions can affect the performance of ELSS funds.

ELSS has a mandatory three-year lock-in period, which disallows withdrawal before expiration. This is both an advantage and a disadvantage; your investment can grow while providing tax benefits during this period, but at the same time, the lock-in blocks access to funds should the need arise.The investment can be withdrawn as liquid money after the lock-in period ends or reinvested in another ELSS for continued benefits. This makes ELSS flexible.ELSS is recommended for investors with long-term goals and high-risk tolerance, so it is advisable to stay invested in these funds longer for higher returns. It helps that ELSS investments enjoy tax benefits.