How can you save tax with mutual funds?
Is a significant amount of your income depleted by taxes? If you want to keep more of what you earn, start focusing more on tax planning. It is a good idea to invest your money in places that help you save taxes as well as allow you to earn money out of the investment.
There are many tax-saving schemes in the market today, and therefore, you have to be wise while selecting the best mutual fund. Looking to claim tax-break by keeping your money in conventional investment options like Public Provident Fund (PPF), National Savings Certificates (NSC) or fixed deposits? Doing this will yield moderate returns. Want to make your money work harder and earn higher returns? A great idea would be to invest in mutual funds. This way you not only get to choose the type of fund you want, but also get tax benefits—unlike when you invest directly in the stock market. This is where Equity Linked Savings Schemes (ELSS)—or tax-planning mutual funds as they are popularly known—come into the picture.
What makes ELSS a good option to invest for saving tax? Here the the 6 ways you benefit from them.
- Returns from an ELSS scheme are tax free
When you invest in a tax saving mutual fund such as ELSS, the amount you receive by way of dividends is tax free. What is more, there is no dividend distribution tax levied on the dividend at the time of payment, thereby ensuring that your earnings from ELSS will be tax free. This is a far cry from investing in fixed deposit in a bank, where you have to pay taxes on the interest earned on the basis of your tax bracket.
- Indexation benefit for capital gains
Now you know that no tax is levied on the long-term capital gains (the difference in the selling price and Indexed purchase price for investments) from ELSS. Investing in mutual funds makes for great indexation benefits too. Indexation benefit let you index the historic cost of certain assets/investments to the present value (based on inflation). This benefit is provided for capital gains on asset held for more than one year depending on the asset category. When you invest in mutual funds and later sell the units at a higher price, you get to avail indexation benefits through the capital gains that you make.
- Tax benefits under Sec 80C of the Income Tax Act
ELSS is one of the best avenues to save tax under Section 80C of the Income Tax Act, 1961. When you invest in equity mutual funds, up to Rs. 1.5 lakh of the invested amount can be deducted from your total taxable income for computing tax.
- Earn higher returns along with tax savings
The ELSS is one tax-saving mutual fund that can earn you risk-adjusted returns in addition to a tax-saving benefit. As an investor, if you have a relatively higher risk appetite, the ELSS makes for a great tax-saving scheme to avail the growth potential of equities and save tax too.
5.Short lock-in period
Did you know that compared to other tax-saving schemes, ELSS has the shortest lock-in period of three years? Investing in ELSS can reduce your taxable income depending on the amount of your investment. This is what constitutes the initial tax benefit.
6. Allows you to invest fixed regular amounts
Looking to invest in a tax-saving scheme but don’t want to put in a lump sum amount? This is where ELSS can help you. It allows you to invest fixed regular amounts through Systematic Investment Plans or SIPs. However, if you’re opting for SIP, you need to remember that every instalment into the ELSS will be considered a separate investment and therefore, will have a three-year lock-in period. This means once you invest in an ELSS tax-saving scheme, you can redeem the units bought in the first instalment only three years later.
The risks regarding investing in mutual funds:
Want to invest in mutual funds only for the tax benefit? While tax benefits on mutual funds are a great reason to invest, it does not mean you should invest in tax-saving mutual funds without caution. Make sure that you invest for the long term, and time the market while doing so. The same holds true for a SIP. Don’t invest a lump sum in equity-linked mutual funds when the markets have risen.
Is there a way to protect yourself against the risks?
While ELSS does involve the risk associated with equity investments, there are ways in which you can hedge these risks. Compared to small cap stocks, the risk in opting for funds which invests in large cap stocks that are market leaders in their sector could be comparatively lower. You can also adjust the risk by opting for a diverse range of tax-saving schemes, and modify your tax-saving strategy accordingly as you grow older or feel the need to reduce risks.
To know more about the benefits of investing in mutual funds, click here: