Apeksha was looking at investing in the stock market to grow a corpus for retirement. As tax season was approaching, she was looking at investing in a tax saving instrument as well. However, since most of her funds were earmarked for mutual funds, she did not have a lot of money to invest in other instruments. On reading about tax saving instruments online, she found out that there was a special category of mutual funds that provide a deduction under Income Tax. Apeksha is not alone. Not many people have clarity about tax saving instruments and when tax season approaches, they pick any random instrument without checking out the benefits of the instrument for them and their corpus goals. Let us understand about tax saving mutual funds in this guide.
Mutual funds are one of the most preferred means of investment in the stock market. The risk of investing in a mutual fund is much lesser than the risk of investing in equities or debt instruments directly, since mutual funds spread their investments across a range of different investments.
Mutual funds are also the instrument of choice for availing a tax benefit under the Income Tax Act. There are special categories of mutual funds on which a tax benefit can be availed.
How to get mutual fund tax benefit?
To get mutual funds investment tax benefits, you need to invest in a scheme called ELSS or Equity Linked Savings Scheme. This scheme has a lock in period of 3 years, which means any investment made under this scheme can only be withdrawn after 3 years are complete. Apeksha can claim tax deduction of up to Rs 1.5 lakh. In addition, she can save up to Rs 45,000 in tax by investing in ELSS.
In case Apeksha chose to redeem her ELSS after the three-year lock-in period, the long-term capital gains (LTCG) up to Rs 1 lakh are tax-free. However, LTCG in excess of Rs 1 lakh is taxed at the rate of 10%.
Equity Linked Savings Schemes are specially designated mutual funds which give the investor a deduction under Section 80C of the Income Tax Act. ELSS funds have the following terms in their names:
• Tax saver fund
• Tax saving fund
• Tax plan
• Tax shield
• Tax gain
• Tax advantage
The deduction is allowed for both lumpsum and systematic investment plans (SIP) type plans. This gives you the flexibility to invest as much as you can in such plans.
The maximum amount of mutual funds SIP tax benefit available is Rs. 1,50,000. You can claim this amount while filing your income tax return. Apeksha can invest her funds in an ELSS scheme and get the required deduction without having to invest in a second tax saving instrument.
How to identify these schemes?
These funds can be identified by reading the mutual fund offer document. Before investing in such schemes, it is better to recheck that these funds are actually ELSS funds and will get you the required deduction.
It is important to remember that the Rajiv Gandhi Equity Saving Scheme (RGESS) deduction is no longer available, hence you should recheck if the scheme you are investing is an ELSS scheme or an RGESS scheme.
How to invest in the right tax saving mutual fund?
Investing in the right tax saving mutual fund takes a significant amount of study. Mutual funds are subject to market vagaries and the returns on these can fluctuate depending on the market performance. ELSS schemes performed well when the market was buoyant but in a bear trend, the performance of these funds suffered.
It is very important to figure out your investment objective before investing in mutual funds. Section 80C of the Income Tax Act is very broad based and there are a lot of different investment options available. Therefore, depending on your investment and life goal, i.e child’s education expenses, wedding expenses, retirement, you can accordingly pick the right investment for you. Mutual funds are an excellent investment option provided you have the ability to bear the risk of an uncertain return. Investment in mutual funds is a long-term game and therefore, if your investment time frame is shorter, it is better to find a more liquid investment option that may not necessarily provide tax benefits.