How to Save Tax with Mutual Funds

To save tax with mutual funds, An ELSS, or an Equity Linked Savings Scheme, is a tax saving mutual fund that allows you, an individual, or HUF a deduction from a total income of a maximum of Rs, 1.5 lakh under Section 80C of the Income Tax Act 1961.

So, as an investor, if you were to invest Rs. 50,000 in an Equity Linked Savings Scheme, then that amount will be deducted from the total taxable income, thereby reducing your tax burden.

In this article, we will be looking at how to save tax with mutual funds, the various types of tax saving mutual funds, and their benefits, among other things.

Tax saving mutual funds, or an ELSS, allows you to reduce your tax burden by allowing a deduction from the total income of a maximum of Rs. 1.5 lakh, as per the Income Tax Act 1961 Section 80C. An Equity Linked Savings Scheme has a 3-year lock-in period, starting from the date of the allotment of units. Once the lock-in period comes to an end, the units are free to be switched or redeemed. Tax saving mutual fund schemes offer growth as well as dividend options.

Let us look at the two ways in detail that an ELSS fund can be categorised into:

1. Growth option: An Equity Linked Savings Scheme growth option could aid you in creating wealth. You as an investor will receive the complete redemption amount as a lump sum at the time of maturity.
2. Dividend option: An Equity Linked Savings Scheme dividend option will give you income throughout the course of the scheme. You as an investor get to choose to be receiving payouts whenever the fund declares dividends, or you may choose to be reinvesting in them.

An Equity Linked Savings Scheme is an equity-oriented mutual fund which is eligible for tax deductions as per the Income Tax Act 1961. A tax saving mutual fund is another name for an Equity Linked Savings Scheme, and can be defined as a mutual fund scheme which invests particularly in equity and equity-related securities. In case of an Equity Linked Savings Scheme, the returns depend on the performance of the stock market. You would have to invest in an Equity Linked Savings Scheme for a minimum of 3 years to be able to gain benefits.

Compared to other tax saving instruments such as National Savings Certificate (or NSC), or Public Provident Fund (PPF), there are no upper limits set for an Equity Linked Savings Scheme fund. In one financial year, however, only an investment of up to Rs. 1.5 lakh would be eligible for the tax benefits. Incomes that come from an Equity Linked Savings Scheme investment are known as Long Term Capital Gains, and are taxed as per the prevalent tax regulations. While you are trying to understand how to save tax with mutual funds, do not forget to take a look at the new regime income tax slabs.

The invested capital is added to the pool when money is being invested in the mutual funds. Thereafter, the portfolio corpus is invested in the equity market in a manner that even in case of one investment facing losses, the other still manages to compensate for the losses. An Equity Linked Savings Scheme usually comes with a 3-year lock-in period, wherein the investments cannot be withdrawn until the end of the maturity period. As an investor, you can only redeem the unlocked units at the current NAV rate in case you want to redeem the units of the fund.

Still confused about how to save taxes with mutual funds? Here’s what a tax saving mutual fund allows you to do:

• You will be able to save up to Rs. 46,800 of taxes with a tax saving fund.
• The average returns are close to 15% in the past 3 years, as compared to fixed deposits or PPFs.
• Tax saving mutual funds, to put it simply, are just like any other mutual fund, but come with tax benefits.

If you happen to be a salaried employee, and are looking to balance out risks and returns in your investment portfolio, the ELSS fund might just be the thing you are looking for. Compared to other tax instruments, the Equity Linked Savings Schemes have the power to generate much higher returns because of their exposure in equities, and the lock-in period which allows the fund manager to manage the portfolio very well without any fear of frequent redemptions within the funds they are managing.

The following are the three options or types available under an Equity Linked Savings Scheme fund:

1. Growth option: Under the growth option of an ELSS fund, your returns get reinvested until the time when you choose to redeem the fund. With this option, the gains can be achieved and utilised by you only at the time of redemption. But, do note that the growth option helps appreciate the NAV in the long run, and thereby yields a higher profit for you as an investor. However, it is important for you to remember that the returns under this option would always be dependent on market risks.
2. Dividend option: Under the dividend option of an ELSS fund, you as an investor will be getting the returns in the form of dividends, which will be entirely tax free. However, you must keep in mind that the fund houses would declare dividends only at times there are excessive profits made.
3. Dividend reinvestment option: Under the dividend reinvestment option, the dividends to be declared would be reinvested in the fund itself to make additions to the NAV. This option would work particularly well when the market is going through an upward momentum for a good amount of time.

Tax saving mutual funds have several benefits for you as an investor, some of which include:

• The investments made in tax saving mutual funds are eligible for tax benefits for up to Rs. 1,50,000.
• The long capital gains that you get with a tax saving mutual fund will not be taxed.
• This plan will allow you as an investor to invest every month through SIPs, therefore negating the need to invest.
• The portfolio assets are spread across various investments, allowing them to grow and increase in value over time.
• If you choose not to withdraw, your investment can build up into a substantial savings fund for future needs.
• Additionally, you can withdraw dividends even during the lock-in period.
• While other investment options may have lock-in periods ranging from 6 to 15 years, mutual funds typically offer a shorter 3-year lock-in period.
• These schemes are open-ended, so investments can be made at any time throughout the year.
• The funds are managed by experienced professionals with extensive market knowledge, making them a suitable option even for those without investment expertise.

Although tax saving mutual funds offer several advantages, you as an investor must also be aware of the risks associated with them, such as:

• ELSS funds come with higher risks as these have a direct link to the equity market. Any equity-related investment is always going to be more prone to market volatility. Therefore, ELSS funds will always come with a high risk factor.
• ELSS funds offer limited liquidity. You must be aware and ready to accept the fact that your funds will remain unavailable to you until the end of the 3-year lock-in period that an ELSS fund has.
• If risk is a huge factor for you, ELSS funds are probably not what you should be going for. As a risk-averse investor, you should be opting for a lower return which comes with a safer option such as PPF or life insurance.

While you are investing in an Equity Linked Savings Scheme tax saving mutual fund, there are certain things that you need to take into consideration to be able to wisely make choices that help you in saving taxes while investing in mutual funds:

1. Goals
   You need to figure out the reasons for which you want to invest in an Equity Linked Savings Scheme fund. Apart from the obvious tax saving factor, the returns could also help you meet other life and/or financial goals such as purchasing a car or going on a vacation.
2. Risk
   An Equity Linked Savings Scheme fund invests in equities mostly, which makes it a risky instrument. You have to be aware that returns cannot be guaranteed. Therefore, it is important for you to have the risk capacity to be investing in an Equity Linked Savings Scheme fund.
3. Tax exemption
   An Equity Linked Savings Scheme fund is eligible for up to Rs. 1,50,000 tax deductions in a financial year, as per Section 80C of the Income Tax Act 1961.
4. Time horizon
   An Equity Linked Savings Scheme fund cannot be redeemed until the end of at least 3 years. You as an investor must be sure that you would not require these funds during that period of time.

As an investor, you need to be aware of the several tax savings schemes that are available in the market. With a better understanding of how to save tax with mutual funds, it would be easier for you to make smart financial decisions, which would help you achieve your goals over time.

If you are also looking to be investing in mutual funds, the Bajaj Finserv Mutual Fund Platform offers over 1,000 mutual funds that you must check out. Additionally, the platform comes with a mutual fund calculator, which would further help you compare mutual funds.