What Type of Mutual Fund Should Be Purchased for Tax Savings?
Tax-saving mutual funds, also known as Equity Linked Savings Schemes (ELSS), are a category of mutual funds specifically designed to offer investors a dual advantage of tax benefits and the potential for capital appreciation. These funds operate under Section 80C of the Income Tax Act, allowing investors to claim a deduction of up to 1.5 lakh from their taxable income. In this detailed guide, we explore the benefits and considerations of investing in ELSS mutual funds to meet your tax planning and financial goals.
Tax Planning in February 2023
As we approach the month of February 2023, it's imperative to consider your tax planning for the current financial year. The last date for making tax-saving investments for the Assessment Year 2022-23 is 31st March 2022. Section 80C of the Income Tax Act of 1961 allows investors to claim deductions of up to 150,000 INR from their taxable incomes by investing in eligible schemes. These include Employee and Voluntary Provident Funds (EPF and VPF), Public Provident Fund (PPF), National Savings Certificates (NSC), 5-year tax-saver bank fixed deposits, life insurance policies, and mutual funds, including ELSS.
How to Plan Your Taxes
Here are the steps to plan your taxes effectively:
Identify your eligible deductions under Section 80C. Calculate the maximum allowable deduction, which is 150,000 INR, regardless of your tax slab. Include contributions to EPF, principal components of home loan EMIs, and life insurance premiums in your total eligible deductions. Utilize the details to determine how much investment you need to claim the full benefit under Section 80C. Select an 80C scheme that aligns with your risk appetite and financial goals.About ELSS Mutual Funds
What is ELSS?
ELSS, or Equity Linked Savings Schemes, are equity mutual fund schemes. Investments in ELSS are eligible for deductions from your taxable income under Section 80C. Although there is no upper limit on investment amounts in ELSS, the maximum deduction allowed under Section 80C is capped at 150,000 INR. ELSS funds have a lock-in period of 3 years, during which no redemption or withdrawal is allowed until the scheme matures.
Investment in ELSS Through Systematic Investment Plan (SIP)
When you invest in an ELSS through a Systematic Investment Plan (SIP), each installment is locked-in for 3 years. This lock-in period is crucial, as it ensures the funds are invested in equity over the long term, reducing the risk of premature withdrawals and capital losses.
Asset Allocation in ELSS
ELSS funds typically invest in equity and equity-related instruments, and they usually diversify across market capitalization segments and industry sectors. While there are no SEBI mandates on market cap allocations, ELSS funds are subject to market risks due to their exposure to equity markets. It's essential to invest according to your risk tolerance and consult with a financial advisor if needed.
Why Invest in ELSS?
Despite the volatile nature of equity, it has historically provided superior returns over long investment horizons. Here’s a breakdown of the average annualized returns of the Nifty 50 TRI index over different investment tenures, ending 31st January 2022:
5 years: 12.5% 10 years: 14.8% 20 years: 16.5%While other financial instruments such as Government small savings schemes and bank fixed deposits have lower interest rates, the potential for higher returns from ELSS funds makes it an attractive option for long-term investors seeking growth.
Choosing the Right ELSS Fund
Every Asset Management Company (AMC) offers at least one tax-saving mutual fund. Some popular options include:
SBI Tax Saver Fund DSP Tax Saver Fund Kotak Tax Saver Fund Nippon Tax Saver Fund Axis Tax Saver FundResearch the performance, fees, and risk profile of each fund to choose the one that best meets your investment goals.
In conclusion, ELSS mutual funds are an effective tool for tax planning and wealth creation. By understanding the benefits and selecting the right fund, you can maximize your returns while minimizing your tax liability.