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Tax-saving mutual funds

Mutual funds aren’t a singular kind of investment. In fact, there are different types of mutual funds which are quite diverse inherently. A popular type of mutual fund is one that offers some tax benefits to its investors. Unsurprisingly, they’re called tax saving mutual funds. In this section, we will take you through their definition, history, advantages, popularity and funds and the likes.

Key Points

  • Tax saving mutual funds are ideal for investors who don’t want to take any risk in the stock market.
  • You cannot withdraw your funds before the maturity date in case of ELSS, so you shouldn’t be putting in money you may need in the short term.
  • Section 80c makes you eligible to reduce your taxable income up to Rs 1,50,000 when you invest in certain assets.

Tax saving mutual funds are ideal for investors who don’t want to take any risk in the stock market. Especially in India, where a lot of people are keen on investing in tax-saving mutual funds. You too can opt for tax-saving mutual funds - they’re risk-free and as the name suggests they reduce your taxable amount.

Understanding tax-saving mutual funds

Tax saving mutual funds, or Equity Linked Savings Scheme (ELSS), are very similar to typical mutual funds, and work on the same principles. However, they come with an added bonus of tax benefits if you have invested in them under Section 80C of the Income Tax Act. With them, you can enjoy the benefits of both capital appreciation as well as tax benefits. You have to stay invested in these type of mutual funds for 3 years or more from the date of investment.

What is section 80c, you ask?

Without getting into too much detail on the technicals - section 80c makes you eligible to reduce your taxable income up to Rs 1,50,000 when you invest in certain assets. Any individual or HUF (husband, wife and children living together) can opt for this deduction.

Historical Fact
Section 80C of the Income Tax Act was introduced in 1961. Until 2006, you could be eligible to reduce your taxable income by upto only Rs 10000. Also till the early 1990s, you could only invest in firms registered in backward areas. This changed gradually to give shape to Section 80C as we know it today.

Advantages of Tax-Saving Mutual Funds or ELSS

  • No tax on capital gains: You are not obliged to pay tax on your profits from tax-saving mutual funds. Since the money you invest in these funds are invested in shares, it does not attract any tax on long term capital gains.
  • Lock in period: In tax-saving mutual funds, you are not obliged to stay invested in these funds for more than 3 years. Unlike Public Provident Funds (PPF), National Savings Certificate (NSC) and bank fixed deposits, the lock in period is lesser. You have to stay invested in PPF, NSC and bank fixed deposit for 15, 6 and 5 years respectively.
  • Better returns: If you are invested in an ELSS, sure you’re subjected to some risk, but it also brings in the potential for the highest return among all the tax-saving investments, since these funds invest their money in the stock market.
    As a matter of fact, in the last 20-25 years, equity mutual funds have delivered the highest returns.
  • SIP option: A SIP, or Systematic Investment Plan, is always an open option. It reduces the risk on your investment by a great factor as it averages in your buying price.

Word of Caution? The Disadvantages of Tax-Saving Mutual Funds

  • Risk: Tax-saving mutual funds are invested in the stock market; so there is some risk. If you are unwilling to take that risk; you are better off avoiding ELSS.
  • Premature withdrawal: You cannot withdraw your funds before the maturity date in case of ELSS, so you shouldn’t be putting in money you may need in the short term. But under some circumstances, you can withdraw your investments from PPF and bank deposits.
Wrapping Up

  • Tax Saving Mutual funds deliver both returns on your investment and tax benefits.
  • You are not obliged to pay tax on your profits from tax-saving mutual funds.
  • Your lock in period for these funds is 3 years, after which you may exit your investments if you wish.
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