Minimizing tax liability is one of the most integral aspects of financial planning. Individuals who fall under the tax bracket seek tax deductions. Section 80C of the Income Tax Act, 1961 allows you to invest in certain financial instruments so as to claim deductions from your taxable income.
Some of the tax-saving investments allowed under Section 80C are Public Provident Fund (PPF), Tax-saving Fixed Deposits (FDs), National Pension System (NPS), Employee Provident Fund (EPF), and Unit Linked Insurance Plans (ULIP), besides others. One of the most popular financial instruments is tax-saving mutual funds.
About tax-saving mutual funds
As the name suggests, it is just like any other mutual fund, but with an added advantage of tax benefits. Such funds are mostly Equity Linked Saving Schemes (ELSS), which offer a host of benefits. Tax-saving funds are highly transparent and come with low charges. They offer good returns as well as high liquidity.
Understanding the mechanism of tax-saving mutual funds
If you decide to invest your money in mutual funds, you will realize that all the funds are added to a single pool. The amount is then diversified in equity markets, in numerous industries such as automotive sector, pharmaceutical sector, or consumer durables, among others. Your fund manager will diversify the funds in such a way that if one sector fails to perform, the risk is mitigated by an investment in another industry.
Benefits of tax-saving mutual funds
There are numerous benefits of investing in ELSS funds. Following are six of them:
- Tax benefits
The most obvious reason to invest in such mutual funds is that the investments are eligible for tax deductions. According to Section 80C, in a financial year, you may claim deductions up to INR 1.5 lakh from your taxable income. Besides, the profits obtained on the sale of ELSS are treated as capital gains, and are tax free in the hands of the investor.
- Disciplined saving
Salaried individuals who fall under the tax slab generally invest in such mutual funds on a monthly basis. Such Systematic Investment Plans (SIPs) ensure disciplined savings, which may then be used to fulfill any financial obligation in the future.
- Risk minimization
Investing in a single stock may result in huge losses in case the market fails to perform. The same is not the case with tax-saving funds, since investments are generally spread over numerous sectors. With such diversity in your portfolio, the degree of risk is reduced to a great extent.
- Lower lock-in period
Lock-in period is a pre-determined amount of time before which the investment cannot be withdrawn. A tax saver mutual fund generally has a lock-in period of three years. This is lower as compared to other investments that come with a 6- to 15-year lock-in period.
- High return potential
Mutual fund managers generally invest a large part of the funds in equity. This helps to amass huge wealth over the long term.
The aforementioned benefits highlight why mutual funds are now becoming a lucrative tax-saving investment option. It not only helps in reducing your tax burden but also builds wealth at the same time.
Method to avail of tax benefits from ELSS
In order to reap tax benefits through ELSS, you may either invest a lump sum amount at any time or a fixed amount every month through SIPs. Investing regularly helps in easing the burden associated with making large investments towards the end of the financial year.
Rajiv Gandhi Equity Saving Scheme
Apart from ELSS, there are other tax-saving funds as well. One such is Rajiv Gandhi Equity Saving Scheme (RGESS). With the objective to encourage savings of small investors in the domestic capital market, Pranab Mukherjee, the then Finance Minister, announced a new Section 80 CCG of the Income Tax Act. According to this Section, investments made under RGESS funds are eligible for tax deductions. Those who have a gross annual income of not more than INR 10 lakh and have not invested in equities earlier may invest in this scheme.
In order to start investing in this scheme, you may open a demat account and submit declaration Form A to the Depository Participant. The investment has a fixed lock-in period of one year and a flexible lock-in period of the following two years. The investments made in the RGESS funds are eligible for tax deductions up to a maximum amount of INR 50,000. You may, therefore, invest in this scheme and enjoy the tax benefits if you are eligible.
There are numerous tax-saving fund options in the market. Research the long-term performance of the funds before making an investment. This will help you gain maximum mutual fund tax benefits along with capital appreciation.