What are Tax Saving Mutual Funds

Mutual funds have become one of the top investments in the recent past. The funds are managed by skilled and trained professionals. Due to this, returns on mutual funds have been better than any other traditional investments like bank fixed deposits, PPF, bank recurring deposit, etc.  In mutual funds, the money is collected from a pool of investors and is invested together in a market like debt bonds and stocks of the various companies. Mutual funds also have various categories and schemes financial objectives. Every mutual fund has an objective of its own like growth, regular income, and short-term liquidity, etc. Growth mutual funds will provide capital growth in long-term; regular income will provide returns on regular intervals, liquid mutual provide returns in short term. While investing in mutual funds and enjoying the returns look like a very attractive proposal, what about the taxes that the investor pays on his/her income? Is there any tax benefit available for investing in mutual funds? The answer to that is yes. The investment made in ELSS (Equity Linked Saving Scheme) provides a tax benefit under Section 80C of the Income Tax Act, 1961. This article talks about tax saving mutual funds in detail.

What are Tax Saving Mutual Funds?

Tax saving mutual funds are similar to other mutual funds available in the market but have an added advantage of providing a tax benefit to the investor for up to a certain limit of investment. Tax saving mutual funds fall in the category of ELSS schemes which come under the provisions of Section 80C of the Income Tax Act, 1961.

How do Tax Saving Mutual Funds Work?

Investments from a pool of investors are clubbed together and invested in equity market under different equity and debt financial instruments. This way if a particular stock in which the investment has been made does not do well, then it gets compensated by a stock that is performing well.

For example – a breakup of the investment in mutual fund looks like this

Automobile industry 5.29%

Banks 18.67%

Consumer durables 7.21%

Consumer non-durables -3.66%

Power 8.92%

Software 9.93%

Pharmaceuticals 10.99%

The loss in the consumer non-durable stocks will get compensated by good returns from bank stocks. This way mutual fund balances the risk and is able to provide good returns due to the diversification of investments in various sectors and different categories of stocks.

There is a lock-in period of 3 years in ELSS schemes; you cannot withdraw the investment until the end of the lock-in period. If the investment is made via SIP (Systematic Investment Plan) monthly, then each individual SIP will have its 3 year lock-in period. For example – If the SIP instalment was made on 1 January, 2018 and the following one on 1st February, 2018 then the lock-in period of the first instalment will end on 1st January, 2021 and the second instalment will remain locked until 1st February, 2021. When it comes to withdrawing the ELSS investment made through SIP, an investor can see how many units have been unlocked or have completed the lock-in period. The unlocked units can then be redeemed at the current NAV (Net Asset Value). To withdraw the mutual fund units, you will be required to fill a claim form and submit to the mutual fund house. After verification of the mutual fund units, your bank account linked with the mutual fund investment will get credited.

Types of ELSS

ELSS mutual funds have two different types of schemes, one is a growth scheme and other is the dividend scheme. The difference between the two schemes is that under dividend scheme the fund announces dividends to the investors. The dividends can be withdrawn anytime and are not bounded by any lock-in periods.  Growth schemes do not have any such provisions.

Features of ELSS Tax Saving Mutual Funds

•    ELSS tax saving mutual funds gives the investors the flexibility of investing small amounts throughout the year. Investors can start an SIP for as little as INR 500 per month to invest in ELSS mutual funds.

•    There is no upper limit for investment in ELSS mutual funds, but investment worth INR 1.5 lakh only will be eligible for tax benefit under Section 80C of the Income Tax Act, 1960.

•    Investment in ELSS mutual fund comes with a lock-in period of 3 years.

•    The inherent risk factor in the ELSS mutual funds can be low, medium or high depending on where the funds are invested.

•    If returns are over INR 1 lakh in tax saving mutual funds, then there is a LTCG tax of 10%

•    Mostly ELSS mutual funds are open-ended schemes.

•    Tax saving mutual funds also offers nomination facilities

•    ELSS mutual funds do not carry an entry and exit load.

Benefits of Tax Saving Mutual Funds

•    Tax saving mutual funds come with a lot of benefits. Some of the benefits are as follows:

•    The most basic and important benefit is that you can save tax on investment of up to INR 1.5 lakhs under Section 80C of the Income Tax Act, 1961 in ELSS mutual funds.

•    Returns from the tax saving mutual funds do not have LTCG tax on a limit of up to INR 1 lakh.

•    ELSS mutual fund investment can help to achieve financial goals like saving money for a car or paying a down payment for a house.

•    Investment is easy, flexible and affordable due to the introduction of SIP (Systematic Investment Plan). People of all income groups can avail the benefit of investing in ELSS mutual funds thereby, saving tax and availing good returns on investment.

•    Risks in mutual funds are mitigated as the investment portfolio is kept diverse to avail benefits from the performance of different industry sectors.

•    You can continue to keep your investment in ELSS mutual funds even after the lock-in period. Your investment will continue to grow as per the performance of your investment in the market.

•    While there is a lock-in period of 3 years in ELSS mutual funds, returns from dividend schemes can be withdrawn any time as per the wish of the investor.

•    Many other investments options have longer lock-in period of 5 years and more, but ELSS mutual funds have a comparatively shorter lock-in period of 3 years only.

•    As the tax saving mutual funds is open-ended, investment can be made all year round.