Tax planning with mutual funds

Personal Finance

In this article you will learn about

  • Saving income tax with mutual funds
  • What is ELSS
  • Advantage of tax savings with ELSS

Taxpayers are an obsessed lot when it comes to saving tax, especially under the umbrella Section 80C of the Income Tax. With over a dozen avenues to save income tax under this section it isn’t an easy process to choose a suitable product. Some of these dozen products are structured to provide assured return while a few offer market-linked returns. The actual tax savings that one could benefit under Section 80C at the highest tax bracket of 30% when deploying the entire Rs 1.5 lakh tax savings in a financial year is Rs 46,800 each year as per current tax laws (including 4% education cess).

When it comes to tax savings; salaried taxpayers contribute a significant tax savings by way of contributions to the employee’s provident fund (EPF) limiting the choice to exhaust the balance to make up for the Rs 1.5 lakh limit which pays out a fixed return. Among the market linked options, the equity linked savings scheme (ELSS) stand out. The ELSS is an equity mutual fund category in which investments qualify for tax deductions under Section 80C. Investments in ELSS have a minimum equity exposure of 80% to qualify as an equity fund, which technically can go up as high as 100%. The ELSS also has the flexibility to invest across market capitalisation, making it offer a flexible and unique investment mandate among equity funds.

Further, investments in ELSS have the shortest lock-in of three years compared to other forms of tax saving instruments where 5-year lock-in is the most common. The three-year lock-in means that you cannot sell your investment before three years from the date of purchase. The mutual fund structure makes investing via systematic investment plan (SIP) convenient and a yearlong exercise with Rs 12,500 each month, instead of rushing at the last moment. However, this lock-in is applicable to every SIP instalment, which means each monthly SIP is locked in for a period of 3 years.

Another reason to consider ELSS as a tax saving option is the potential for higher returns. The equity exposure effectively earns returns that regularly beat inflation compared to the many fixed return tax saving option such as PPF, 5-year FD, NSC etc which barely manage to beat inflation. Moreover, over the past decade the assured returns from such tax savers have been on a decline, reducing their attractiveness.

The ELSS also scores on being tax efficient with the gains it makes and at the time of redemption. ELSS offers better post-tax returns, because the long term capital gains (LTCG) of up to Rs 1 lakh a year from ELSS mutual funds are exempt from income tax, with gains above this limit being taxed at 10%. Among the other tax saving options, except the PPF, gains in case of all other tax savings avenues are taxed partially or totally.

The tax savings cum wealth creation characteristic of ELSS makes it suitable for all investors and stands out as a good first equity investment option. First time investors benefit from the mandatory lock-in and tax savings provide incentive for the uninitiated. Experienced investors could benefit by including ELSS into their investment portfolios to meet their financial goals. Overall, taxpayers can benefit from the all-round feature-packed structure to ELSS to reduce their income tax liability, experience mutual fund investing and build wealth.

Next steps

  1. Figure how much you need to set aside to save tax
  2. Choose an ELSS to invest
  3. Use the SIP or lump sum route to tax savings in ELSS

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All Mutual Fund investors have to go through a one-time KYC (Know Your Customer) process. Investors should deal only with Registered Mutual Funds (‘RMF’). For more info on KYC, RMF & procedure to lodge/redress complaints, visit pgimindiamf.com/IEID. This is an investor education and awareness initiative by PGIM India Mutual Fund. Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

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