What are Tax Saving Mutual Funds & How to Invest in Them?
Saving taxes while potentially growing your wealth is a goal shared by many investors. Among the various tax-saving investment options, tax saving mutual funds, also known as Equity Linked Savings Schemes (ELSS), have gained significant popularity.
The top tax saving mutual funds offer a unique blend of tax benefits and market exposure, making them an attractive choice for investors seeking to optimise their tax liabilities. In this blog, we will delve into the world of tax saver mutual funds and explore their features, benefits, and considerations.
What are Tax Saving Mutual Funds?
Tax Saving Mutual Funds, also recognised as ELSS mutual funds, are mutual funds that offer tax benefits to investors under Section 80C of the Income Tax Act in India. These funds, including best ELSS and quant ELSS, primarily invest in equity shares of companies across different sectors. They are designed to provide long-term capital appreciation while offering tax deductions on the amount invested, positioning themselves as tax saver scheme for many investors.
How to Invest in Tax-Saving Mutual Funds?
Investing in tax saving mutual funds can be a straightforward process. Here’s a guide to get you started:
- Open a demat/trading/brokerage account. Investors can open a demat account with smallcase!
- Register online at any AMC website.
- Explore different tax saving funds to figure out which one suits your investment objectives.
- Investors can use tools like the Tickertape Mutual Fund Screener to sort through these funds, create a list of ELSS mutual funds and explore their fundamentals and performance in the past.
- Proceed to invest by clicking on the appropriate option and specifying the amount and investment mode (SIP or Lumpsum).
- Submit your KYC details, including your PAN number and bank details, to finalise your investment.
Note: It is important to conduct thorough research and consult a financial advisor before investing in anything.
Key Features of Tax-Saving Mutual Funds
- Tax Benefits: Tax-saving mutual funds offer tax deductions under Section 80C of the Income Tax Act, 1961. You can claim a deduction of up to Rs. 1.5 lakhs on your investment in tax saver funds.
- Investment Options: These funds offer a variety of investment options, so you can choose the one that best suits your investment goals and risk tolerance, making them some of the best tax saver plans available.
- Professional Management: These funds are professionally managed by experienced fund managers, ensuring that your money is strategically placed in equity ELSS and other assets.
- Liquidity: ELSS SIP options within these funds are liquid, meaning that you can easily buy and sell your investments.
- Low Expense Ratio: These funds typically have a low expense ratio, ensuring that you keep more of your investment ELSS returns.
How Do They Work?
ELSS funds, including those aiming for long-term equity fund direct growth, work by pooling money from a large number of investors and investing it in a diversified portfolio of equity and equity-related instruments. The fund manager will typically invest in a mix of large-cap, mid-cap, and small-cap stocks, as well as in other equity-related instruments such as equity-linked debt funds and exchange-traded funds (ETFs).
The performance of ELSS funds will depend on the performance of the underlying equity market. In the long term, equity markets, including those focused on taxation of equity mutual funds, have historically delivered higher returns than other asset classes such as fixed income. However, equity markets are also more volatile, which means that there is a risk of losing money if you invest in ELSS tax saving options.
Eligibility Criteria and Lock-In Period
Here are the eligibility criteria and lock-in period for tax-saving mutual funds (ELSS):
Eligibility Criteria
- You must be a resident Indian.
- You must have a PAN number.
- You must invest in the fund through a registered broker or distributor.
Lock-in Period
ELSS funds have a lock-in period of three years. This means that you cannot withdraw your money from the fund within three years of investing. If you do withdraw your money before the lock-in period is over, you will be liable to pay a penalty of 1% per month on the amount withdrawn. This makes them a strategic tax saving scheme despite the restriction.
How to Choose the Best Tax Saving Mutual Funds?
To effectively choose the top ELSS funds, you can follow a step-by-step approach that simplifies the process while taking into account the important factors. You can check out our collection of top 10 ELSS funds here! Here’s one way to go about choosing which ELSS mutual fund is best for your portfolio:
Define your financial goals
- Short-term vs. Long-term: ELSS funds have a 3-year lock-in, but consider your goals beyond that. Are you saving for retirement, a house, or education? Deciding on this can influence the type of fund you invest in.
Determine Your Risk Tolerance
- Equity investments can be volatile. Hence, finding out your risk tolerance levels before you decide to invest can help you in the long term.
Research Fund Performance
- Historical Returns: Look at 3, 5, and 10-year performance data. It can help you understand the fund’s performance over the years.
- Compare with Benchmarks: See how the fund performs relative to its benchmark and category averages.
Evaluate the Fund Manager(s)
- Experience and Track Record: A seasoned fund manager with a history of navigating market cycles can significantly impact fund performance.
Analyse the Fund’s Portfolio
- Diversification: It can be helpful to ensure that the fund has a diversified portfolio across sectors and companies to mitigate risk.
- Investment Strategy: Growth, value, or a mix? It can be helpful to choose one that matches your own investment philosophy and goals.
Diversify Your Investments
- Spread Your Investment: You can consider investing in more than one ELSS fund to spread risk and capitalise on different management strategies. For this, it is worthwhile to consult a financial advisor before investing.
Regular Review and Rebalance
- Monitor Performance: It can be helpful to keep an eye on your investments and market conditions. You can be prepared to make adjustments if your financial goals or risk tolerance changes when considering the best ELSS mutual funds.
Advantages of Investing in Tax Saving Mutual Funds
There are many advantages to investing in tax saving funds (ELSS). Some of the key advantages include:
- Tax Benefits: Mutual funds under 80C of the Income Tax Act, 1961 offer tax benefits. This means that you can claim a deduction of up to Rs. 1.5 lakhs on your investment in ELSS funds from your taxable income.
- Potential for High Returns: ELSS funds invest in equity markets, which have the potential to generate higher returns than other asset classes, such as fixed deposits or bonds. Over the long term, the best ELSS funds to invest in 2024 have the potential to generate returns of 15-20%.
- Flexibility: ELSS funds have a lock-in period of 3 years, which is the shortest lock-in period for any tax saving investment. This gives you more flexibility to withdraw your money if you need it.
- Convenience: These mutual funds can be easily bought and sold through a variety of channels, such as online portals, mutual fund houses, and banks. This makes it easy to invest in ELSS funds even if you don’t have a lot of time or expertise.
Disadvantages of Investing in Tax Saving Mutual Funds
While ELSS tax saving mutual funds offer numerous advantages, they also come with risks and considerations.
- High Risk: Tax saving funds are equity-oriented funds, which means that they are subject to market volatility. This means that your investment can go down in value as well as up, even in the case of the best performing ELSS mutual funds in India.
- Lock-in Period: Tax saving mutual funds have a lock-in period of 3 years. This means that you cannot withdraw your money from the fund before the end of the lock-in period without incurring penalties. This means that even the best ELSS fund to invest in will be susceptible to long term market risks.
- Entry and Exit Loads: Some tax saving mutual funds charge entry and exit loads. These are fees that you have to pay when you buy or sell units of the fund.
- Management Fees: Tax-saving mutual funds charge management fees. These are fees that are paid to the fund manager and other fund expenses.
Taxation of on Tax Saving Mutual Funds as per the Union Budget 2024-25
Tax saving mutual funds or ELSS funds are equity funds that are taxed accordingly. While investors can use an online ELSS tax calculator to calculate their taxes, being aware of these tax implications is essential for making informed financial decisions. The Union Budget for 2024-25 has made significant changes to the taxation on equity mutual funds. Here we have listed these changes, along with the revised tax rates for equity mutual funds:
Short-Term Capital Gains Tax
Any gains made when holding equity mutual funds for less than 12 months are considered short-term capital gains. The Union Budget 2024-25 increased the tax rate on these gains to 20%. The STCG tax rate was previously 15%.
Long-Term Capital Gains Tax
For equity mutual funds held for over a year, gains are classified as long-term capital gains. The new budget introduces these key changes:
- Tax-Free Limit: The capital gains up to Rs. 1.25 lakh per year are tax-free. This is an increase from the previous limit of Rs. 1 lakh.
- Tax Rate: The gains exceeding Rs. 1.25 lakh are now taxed at a flat rate of 12.5%. This is an increase from the previous rate of 10%.
- Indexation: The benefit of indexation, which allowed investors to adjust the purchase price for inflation, has been removed for all asset classes, including equity mutual funds.
Indexation was a method that allowed investors to adjust the purchase price of assets for inflation. This adjustment reduced taxable profits when selling assets like property or gold. Previously, these long-term capital gains were taxed at 20%. The new rule imposes a flat 12.5% tax on all long-term capital gains but eliminates any indexation benefits.
| Capital Gains Tax | Holding Period | Old Rate | New Rate |
| Short-Term Capital Gains (STCG) | Less than 12 months | 15% | 20% |
| Long-Term Capital Gains (LTCG) | More than 12 months | 10% | 12.50% |
Who Should Invest in Tax Saving Funds?
- First-Time Equity Investors: Individuals new to the equity market can find ELSS funds an appealing entry point. These funds not only provide exposure to equities but also offer tax benefits, making them an excellent starting point for building a diverse portfolio.
- Taxpayers Seeking Deductions: For salaried and self-employed individuals looking to maximise their tax savings under Section 80C, ELSS tax-saving mutual funds can present an attractive option. These schemes allow investors to claim deductions up to Rs. 1.5 lakh per annum, thereby reducing their taxable income.
- Long-Term Wealth Builders: Given their equity component, ELSS funds can be well-suited for investors with a long-term investment horizon. ELSS fund usually have a lock-in period of 3 years, and those with an investment horizon of 3 years and above may find these funds attractive.
- Risk-Tolerant Investors: ELSS funds, being equity-oriented, come with a degree of market risk. Individuals comfortable with market volatility and looking for higher returns compared to fixed-income tax-saving instruments may find ELSS schemes appealing.
- Systematic Investment Planners: Investors preferring systematic tax saving investments can opt for Tax saver SIPs (Systematic Investment Plans) in ELSS funds. This approach not only disciplines the investment process but also helps in averaging the cost of investment over time.
Factors to Consider When Investing in Tax-Saving Mutual Funds
Here are the factors that you should consider before investing in best ELSS or tax saving scheme:
- Fund Performance and Historical Returns: This is a good indicator of how the fund has performed in the past. However, it is important to remember that past performance is not a guarantee of future results.
- Fund Manager Expertise and Track Record: The fund manager is responsible for making investment decisions for the fund. Hence, it is important to choose a fund manager who has experience and a proven track record of success.
- Investment Objective and Risk Profile: Even the top tax saver mutual fund can have different investment objectives and risk profiles. Therefore, it is important to choose a fund that aligns with your own investment objectives and risk tolerance.
- Expense Ratio and Associated Costs: The expense ratio is a measure of the fees charged by the fund. Hence, it can be helpful to look for funds with lower expense ratios.
To Wrap It Up…
Tax saving mutual funds (ELSS) offer a compelling investment option for individuals looking to save taxes while potentially earning higher returns. These funds not only provide tax deductions under Section 80C but also offer the benefits of equity investments. However, it’s crucial to remember that investing in tax saving mutual funds involves market risks, and past performance may not guarantee future results. Investors should consider their risk tolerance, investment objectives, and financial goals before making any investment decisions.
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Frequently Asked Questions About Tax Saving Mutual Funds
Tax saving mutual funds are mutual funds that offer ELSS fund tax benefits under Section 80C of the Income Tax Act, India.
No, ELSS funds are not tax-free. While investments in ELSS funds qualify for tax deductions under Section 80C, the capital gains made from the top tax saver mutual funds are subject to taxation.
The maximum limit for tax deductions under Section 80C, which includes ELSS investments, is Rs. 1.5 lakh per financial year.
Yes, certain mutual fund investments are eligible for tax savings under Section 80C. Tax saving mutual funds, specifically ELSS funds, qualify for tax deductions up to Rs. 1.5 lakh. Other mutual funds, such as debt funds or equity funds, do not offer specific tax benefits.
The choice between ELSS and Public Provident Fund (PPF) depends on individual choices and financial goals. ELSS offers potentially higher returns as it primarily invests in equities, but it comes with market-related risks. PPF, on the other hand, is a fixed-income instrument with a guaranteed return but offers lower returns compared to equities.
The best mutual fund for tax savers is often considered to be ELSS (Equity Linked Savings Scheme) due to its dual benefits of tax savings under Section 80C and potential for high returns through equity investments.
