Tax Saving Mutual Funds

Tax-saving mutual funds, or ELSS (Equity Linked Savings Scheme), enable individuals and HUFs to reduce taxable income under Section 80C of the Income Tax Act, 1961. ELSS investments have a three-year lock-in period and offer tax deductions up to Rs. 1.5 lakh.
EXPLORE FUNDS
What are Tax Saving Mutual Funds?
EXPLORE FUNDS
4 mins
17-November-2024

Tax Saving Mutual Funds, specifically Equity Linked Saving Schemes (ELSS), stand out as attractive options for investors seeking tax benefits with wealth appreciation.

ELSS funds aid in tax savings by enabling a deduction of up to Rs. 1,50,000 from taxable income under Section 80C of the Income Tax Act. They feature a brief lock-in period of three years, the shortest among tax-saving investments, and hold promise for significant returns.

Tax Saving Mutual Funds, commonly known as ELSS, are a category of mutual funds designed to offer benefits of tax savings under Section 80C of the Income Tax Act. The potential for wealth creation through equity investments is high. These funds have a lock-in period of three years, distinguishing them from traditional tax-saving options.

Features of tax-saving mutual funds

  • Tax benefits: Tax-saving mutual funds, or Equity Linked Saving Schemes (ELSS), offer significant tax advantages under Section 80C of the Income Tax Act, 1961. Investors can claim a deduction of up to ₹1.5 lakh on their annual investments in these funds.
  • Diverse investment options: These funds provide a range of investment options, catering to various investor profiles and risk tolerances. This flexibility allows investors to align their investments with their long-term financial goals.
  • Expert portfolio management: ELSS funds are managed by seasoned investment professionals who employ strategic asset allocation and risk management techniques to optimise returns.
  • Liquidity: ELSS funds offer liquidity through Systematic Investment Plans (SIPs), enabling regular, disciplined investing and easy redemption of units.
  • Competitive expense ratios: These funds typically have competitive expense ratios, maximising the potential returns for investors.

By combining tax benefits, professional management, and liquidity, tax-saving mutual funds present a compelling investment opportunity for individuals seeking long-term wealth growth and tax efficiency.

5 features of ELSS mutual funds

Here are 5 features of ELSS mutual funds:

  1. Equity Investment: ELSS primarily invest in equities, providing investors an opportunity to participate in the potential growth of the stock market.
  2. Lock-in Period: ELSS funds have a mandatory lock-in period of three years, the shortest among any 80C tax-saving instrument, promoting long-term wealth creation.
  3. Diversification: ELSS portfolios are diversified across sectors and market caps, reducing concentration risk and enhancing stability.
  4. Lump Sum or SIP: Investors can choose between lump sum investments or Systematic Investment Plans (SIPs), offering flexibility in investment strategies.
  5. Tax Benefits: ELSS funds provide tax deductions up to Rs. 1.5 lakh under Section 80C, making them an efficient tax-saving tool.

How do tax saving mutual funds work?

Tax Saving Mutual Funds invest predominantly in equity and equity-related instruments, aligning with the market's growth potential. The lock-in period ensures a disciplined investment approach and encourages investors to stay committed to their financial goals.

Advantages of investing in tax saving mutual funds

Equity-Linked Savings Schemes (ELSS) offer a compelling investment option for individuals seeking both tax benefits and potential for long-term growth.

Key advantages of investing in ELSS include:

  • Significant tax benefits: ELSS investments qualify for tax deductions under Section 80C of the Income Tax Act, 1961, allowing investors to reduce their taxable income by up to ₹1.5 lakh per financial year.
  • Potential for higher returns: As equity-oriented funds, ELSS primarily invest in stocks, which historically have the potential to outperform other asset classes like fixed deposits or bonds over the long term.
  • Shortest lock-in period: With a mandatory lock-in period of just three years, ELSS offers greater flexibility compared to other tax-saving instruments.
  • Ease of investment: ELSS can be conveniently purchased and redeemed through various channels, including online platforms, mutual fund houses, and banks, making it accessible to a wide range of investors.

Disadvantages of investing in tax saving mutual funds

While ELSS offer tax benefits under Section 80C of the Income Tax Act, it's important to consider the following potential drawbacks:

  • Market volatility: As equity-oriented schemes, ELSS are subject to market fluctuations. This implies that the value of your investment may experience both upward and downward trends, regardless of the fund's historical performance.
  • Lock-in period: ELSS investments are subject to a mandatory lock-in period of three years. This means that you cannot redeem your investment before the end of this period without incurring penalties.
  • Fund expenses: ELSS, like other mutual funds, incur expenses such as management fees and other operational costs, which may impact overall returns.
  • Entry and exit loads: Some ELSS may impose entry and exit loads, which are fees charged when you invest in or redeem units from the fund.

Who should invest in tax saving funds?

  • New investors: ELSS funds offer a prudent entry point into the equity market. By combining tax benefits with potential long-term growth, they provide a solid foundation for building a diversified investment portfolio.
  • Tax-savvy individuals: For those seeking to optimize their tax deductions under Section 80C of the Income Tax Act, ELSS funds present a compelling option. Investors can claim up to Rs. 1.5 lakh in deductions annually.
  • Long-term investors: Given their equity-oriented nature, ELSS funds are well-suited for individuals with a long-term investment horizon. With a mandatory lock-in period of three years, these funds can be part of a strategic wealth accumulation plan.
  • Risk-tolerant investors: ELSS funds are subject to market volatility. Investors with a higher risk appetite and the expectation of superior returns compared to fixed-income tax-saving instruments may find these funds attractive.
  • Systematic investors: Systematic Investment Plans (SIPs) in ELSS funds offer a disciplined approach to investing. By averaging the purchase cost over time, SIPs can help mitigate the impact of market fluctuations.

Why invest in tax saving funds?

Equity-Linked Savings Schemes (ELSS) offer a compelling investment option for individuals seeking to optimise their tax benefits while capitalising on the potential for substantial long-term growth. Compared to traditional tax-saving instruments such as Fixed Deposits, Unit Linked Insurance Plans (ULIPs), and Public Provident Fund (PPF), ELSS provides unique advantages:

Key benefits of ELSS:

  • Optimal tax efficiency: Invest up to Rs. 1.5 lakh annually to claim tax deductions under Section 80C of the Income Tax Act.
  • Flexible investment options: Choose between lump sum investments or Systematic Investment Plans (SIPs) starting from as low as Rs. 1,000 per month.
  • Shortest lock-in period: With a 3-year lock-in period, ELSS offers greater liquidity compared to other tax-saving instruments.
  • High growth potential: By investing in a diversified portfolio of equities, ELSS funds aim to generate superior returns over the long term.
  • Tax-efficient returns: Gains from ELSS up to Rs. 1 lakh per year are tax-free, making it a lucrative avenue for wealth accumulation.

How to evaluate the best ELSS mutual funds?

Criteria

Description

Fund returns

Compare the fund's performance with its peers over several years to assess consistency. Past performance does not guarantee future returns, which hinge on market dynamics and fund manager decisions. Invest based on consistent historical performance.

Fund history

Opt for fund houses with a strong track record spanning 5 to 10 years. A fund's performance is judged by the quality of stocks in its portfolio and benchmark performance.

Expense ratio

The expense ratio reveals the percentage of your investment used for fund management. Lower expense ratios mean higher net returns. Choose funds with similar track records and asset allocation but lower expense ratios for better returns.

Financial ratios

Analyse various metrics like Standard Deviation, Sharpe Ratio, Sortino Ratio, Alpha, and Beta to evaluate fund performance. Funds with higher Standard Deviation and Beta pose greater risk. Opt for funds with higher Sharpe Ratio for superior risk-adjusted returns.

 

How can you save Rs. 46,800 in tax through ELSS?

ELSS is a type of mutual fund that is eligible for tax deductions under Section 80C of the Income Tax Act in India. This means that you can reduce your taxable income by up to Rs 1.5 lakh per year by investing in ELSS.

Here’s how much tax you can save depending on your income tax bracket:

For example, if you are in the 30% income tax bracket, you can save up to Rs 46,800 in tax by investing Rs 1.5 lakh in ELSS. This is because you would get a tax deduction of Rs 45,000 on your investment, plus an additional Rs 1,800 in health and education cess savings.

  • Maximum amount you can invest under Section 80C for ELSS: Rs. 1,50,000
  • Income tax rate: 30%
    • Income tax saved: Rs. 45,000 (Rs. 1,50,000 x 0.3)
    • Health and education cess @ 4%: Rs. 1,800 (Rs. 45,000 x 0.04)
    • Total tax saved: Rs. 46,800 (Rs. 45,000 + Rs. 1,800)
  • Income tax rate: 20%
    • Income tax saved: Rs. 30,000 (Rs. 1,50,000 x 0.2)
    • Health and education cess @ 4%: Rs. 1,200 (Rs. 30,000 x 0.04)
    • Total tax saved: Rs. 31,200 (Rs. 30,000 + Rs. 1,200)

ELSS is a good option for people who are looking to save tax and grow their wealth over the long term. However, it is important to note that ELSS investments are subject to market risk, which means that the value of your investment can go down as well as up. You should carefully consider your investment goals and risk tolerance before investing in ELSS.

How to invest in tax saving mutual funds?

Investing in Tax Saving Mutual Funds is a streamlined process. Investors can choose from various online investment platforms like Bajaj Finserv, to invest in the ELSS fund of their choice. KYC compliance is a prerequisite, followed by selecting the desired ELSS fund based on risk tolerance and financial goals.

Comparing tax saving through mutual funds with other tax saving options

When considering tax-saving investments, a multitude of options are available, including Fixed Deposits (FDs), Public Provident Fund (PPF), National Savings Certificates (NSC), and National Pension System (NPS). However, Equity-Linked Savings Schemes (ELSS) offer a unique advantage: the potential for higher returns coupled with tax benefits.

While traditional options like FDs, PPF, and NSC provide steady returns, they are subject to taxation. ELSS, on the other hand, offers tax benefits under Section 80C of the Income Tax Act, with a relatively shorter lock-in period of three years.

A comparative table:

Investment option

Returns

Lock-in period

Tax on returns

5-Year Bank Fixed Deposit

5-7%

5 years

Taxable

Public Provident Fund (PPF)

6-8%

15 years

Tax-free

National Savings Certificate (NSC)

6-8%

5 years

Taxable

National Pension System (NPS)

7-10%

Till Retirement

Partially Taxable

Equity-Linked Savings Scheme (ELSS)

10-12%

3 years

Partially Taxable

 

Factors to consider when investing in tax-saving mutual funds

Essential factors for prudent tax-saving mutual fund investments:

  • Fund performance analysis: Assessing a fund's historical performance, particularly relative to its benchmark index, can provide valuable insights into its potential future returns.
  • Fund manager's track record: The experience, qualifications, and investment philosophy of the fund manager play a pivotal role in shaping the fund's performance.
  • Alignment of investment objectives and risk tolerance: It's imperative to select a fund whose investment objectives and risk profile are consistent with your individual financial goals and risk appetite.
  • Expense ratio considerations: A lower expense ratio can translate to higher net returns over the long term, making it a crucial factor in fund selection.

choose the option that best suits your target audience and the desired level of detail. remember to tailor the language and tone to the specific context of your communication.

Conclusion

Tax Saving Mutual Funds, particularly ELSS, emerge as a compelling avenue for individuals keen on optimising their tax liabilities while participating in the wealth creation potential of equity markets. These funds offer a unique blend of tax efficiency, professional management, and the prospect of substantial returns.

Essential tools for mutual fund investors

Mutual Fund Calculator

Lumpsum Calculator

SIP Calculator

Step Up SIP Calculator

SBI SIP Calculator

HDFC SIP Calculator

Nippon India SIP Calculator

ABSL SIP Calculator

Tata SIP Calculator

BOI SIP Calculator

Motilal Oswal Mutual Fund SIP Calculator

Kotak Bank SIP Calculator

Frequently asked questions

What is a tax saving mutual fund?

A tax saving mutual fund, or ELSS (Equity Linked Savings Scheme), allows investors to save tax under Section 80C of the Income Tax Act. These funds primarily invest in equity and have a mandatory lock-in period of three years.

Is it worth investing in tax saver mutual funds?

Investing in tax saver mutual funds can be beneficial due to potential returns from equity investments and tax savings up to Rs. 1.5 lakh annually under Section 80C. However, risks associated with equity markets should be considered.

How do I check if my mutual fund is a tax saver?

Verify if your mutual fund is a tax saver by checking its scheme name or category. ELSS funds explicitly mention their tax-saving nature in their documentation and marketing materials.

How to choose a tax saver mutual fund?

When choosing a tax saver mutual fund (ELSS), consider factors such as past performance, fund manager expertise, expense ratio, and investment tenure aligned with your financial goals and risk tolerance.

What is the difference between tax saver mutual fund and normal mutual fund?

Tax saver mutual funds (ELSS) have a lock-in period of three years, during which investors cannot redeem their investments. This period is shorter compared to other mutual funds which do not offer tax benefits under Section 80C.

What is the lock period for tax saving mutual funds?

Tax saving mutual funds (ELSS) have a lock-in period of three years, during which investors cannot redeem their investments.

Can I break my tax saver mutual fund?

Breaking a tax saver mutual fund (ELSS) before the lock-in period of three years is not permitted, except under specific conditions like the investor's demise or disability.

Which SIP is tax free under 80C?

SIPs (Systematic Investment Plans) in ELSS mutual funds qualify for tax benefits under Section 80C of the Income Tax Act, subject to the overall limit of Rs. 1.5 lakh per financial year.

What is the limit of tax saving mutual funds?

The maximum limit for tax saving through mutual funds under Section 80C is Rs. 1.5 lakh per financial year, which includes investments in ELSS funds, PPF, NSC, etc.

How to invest in ELSS mutual funds through SIP online?

To invest in ELSS mutual funds through SIP online, select a fund house offering ELSS, register with their online platform, complete KYC, choose the SIP amount and duration, and authorize payments through net banking or other accepted modes.

How to invest a lump sum in ELSS mutual funds?

To invest a lump sum in ELSS mutual funds, identify a suitable fund based on your risk profile and financial goals, complete the necessary KYC with the chosen fund house, and initiate the investment through their online platform or authorized intermediaries.

How do I know if my mutual fund is a tax saver?

Equity-Linked Savings Schemes (ELSS) are a category of mutual funds that offer tax deductions of up to Rs. 1.5 lakhs under Section 80C of the Income Tax Act. These funds have a mandatory lock-in period of three years. To avail the tax benefits, it is essential to verify if your Systematic Investment Plan (SIP) is invested in an ELSS scheme.

What is the difference between tax saving fund and ELSS?

Equity-Linked Savings Schemes (ELSS) offer a shorter lock-in period of three years compared to the five-year lock-in period of Tax Saver Fixed Deposits (FDs). This shorter commitment period makes ELSS a more attractive option for investors seeking tax benefits.

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The information contained in this article is for general informational purposes only and does not constitute any financial advice. The content herein has been prepared by BFL on the basis of publicly available information, internal sources and other third-party sources believed to be reliable. However, BFL cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. 

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