A Guide to Understanding Tax Saving in Mutual Fund Investments

What are Tax-Saving Mutual Funds?

A tax saving MF is known as an equity-linked savings scheme (ELSS). It allows an individual a deduction from taxable income under Section 80C of the Income Tax Act. The maximum deduction allowed in a financial year is the amount invested or Rs. 1,50,000, whichever is lower.

As per SEBI guidelines, an ELSS has to invest a minimum of 80% of its total assets in equity and equity-related instruments. Now that we understand what are tax saver mutual funds, let us look at how we can use them to invest towards our financial goals.

Features and Benefits of ELSS

1)      High risk, high return potential

ELSS schemes invest most of their money in equities. Equities are volatile and vulnerable to falls in the short term. Hence, they carry high risk in the short term. However, in the long term, the risk reduces. In the long run, you can benefit from the power of compounding. Hence, ELSS schemes are a high-risk, high-return potential investment option.

2)      Lock-in period

A tax saver mutual fund has a lock-in period of three years from the investment date. If you are investing through the systematic investment plan (SIP) route, every instalment has a lock-in period from the investment date.

3)      Low investment amount

The minimum investment amount of an ELSS is very low. Some AMCs offer investments starting from as low as Rs. 500. Thus, they are affordable to most investors across various income categories.

4)      Easy accessibility

ELSS schemes are easily accessible through various channels. You can invest in them by visiting the AMC’s branch office or website, intermediaries like mutual fund distributors (MFDs) or fintechs.

Tax-Saving Mutual Funds and Long-Term Goal Achievement: Two Birds With One Stone

For long-term financial goals, where the investment time horizon is more than seven years, it is recommended that an individual invest in equity mutual funds. ELSS schemes invest most of their money in equities. Equities have the potential to give inflation-beating high returns. In the long run, you can benefit from the power of compounding and create wealth for yourself.

Thus, with ELSS tax saving funds, you get the dual benefits of saving tax and investing towards your long-term financial goals.

How to Choose the Best Tax Saver Mutual Fund?

There are different types of ELSS schemes available in the market. They can be categorised based on active and passive ELSS schemes. Till 2022, we had only active ELSS schemes. In the active schemes category, most AMCs offer ELSS plans. Most of these ELSS schemes provide exposure to large and mid-cap companies. As these schemes are actively managed, the fund manager decides which company shares to buy and sell, the quantity, price, etc. The aim is to beat the benchmark index and provide superior returns to investors.

In 2022, SEBI paved the way for passive ELSS schemes. Since then, some AMCs have introduced passive ELSS schemes. Passive ELSS schemes are available on indices like the Nifty 50, Nifty LargeMidcap 250, etc. While the Nifty 50 Index provides exposure to India’s top 50 companies, the Nifty LargeMidcap 250 Index provides exposure to India’s 100 large-cap companies and 150 mid-cap companies. Apart from tax benefits, passive ELSS schemes provide the benefits of diversification, free of fund manager bias, low expense ratio, etc.

To select the top tax saving mutual funds, you should work with an investment expert. They can do your need analysis and provide a customised solution. While selecting the ELSS scheme for investment, you should look at the consistency of returns over the years rather than returns in the last one and/or three years.

How to Maximise Tax Savings with Mutual Funds?

To maximise tax savings with ELSS funds, you should invest through the systematic investment plan (SIP) route. Every SIP instalment made during the financial year will qualify for a deduction from taxable income under Section 80C. If the total of your ELSS SIP instalments in a financial year is more than Rs. 1,50,000, you will be able to maximise your tax savings. If the total of ELSS SIP instalments in a financial year is lower than Rs. 1,50,000, you can club it with your other tax-saving investments to maximise your tax savings.

Thus, you can invest in a combination of ELSS and other financial products eligible for deduction under Section 80C to maximise your tax savings.

ELSS: Ideal Combination of Tax Savings and Good Returns Potential

ELSS provides you an opportunity to avail a deduction of up to Rs. 1,50,000 from your taxable income. Apart from that, it provides you an opportunity to invest in equities and benefit from their high return potential in the long term. Equities are ideal for investing towards the fulfilment of long-term financial goals. Thus, ELSS is an ideal combination of tax savings and good returns potential.

FAQ 

Apart from ELSS, which are the other financial products that qualify for a deduction under Section 80C?

Apart from ELSS, some other financial products that qualify for a deduction from taxable income under Section 80C include the following.

• Employee Provident Fund (EPF)
• Public Provident Fund (PPF)
• National Savings Certificate (NSC)
• Home loan principal repayment
• Children’s education fees
• 5-years tax saving fixed deposit
• Life insurance premium
• National Pension Scheme (NPS)
• Sukanya Samriddhi Yojana (SSA), etc.

How much is the maximum tax that an individual can save by investing in an ELSS?

Depending on the individual’s tax bracket, the maximum tax they can save is as follows.