It’s never too early to start your tax planning, and sooner the better, whether for the current financial year or in advance for the next financial year. Among the numerous options available for tax saving investments, tax saving mutual funds are one option you can consider to get good returns on your investment as well as save tax.
Tax Saving Mutual Funds
Tax saving mutual funds are a type of diversified equity mutual fund in which your investments qualify for a tax deduction. They are also referred to as Equity Linked Saving Scheme (ELSS).
How is it different from other mutual funds?
Currently, investments up to Rs 1.5 lakhs / year made in tax saving mutual funds qualify for a tax deduction under Section 80C. These funds have a lock-in of 3 years from the date of each fresh investment made in the fund.
Are gains from such funds taxable?
Earlier, gains from equities and equity funds were considered tax-free when held and sold after 12 months. All that changed after the re-introduction of Long Term Capital Gains Tax in Budget 2018. As there is a lock-in of three years, there will be capital gains tax applicable for tax saving mutual funds depending on your gains from the sale.
In case you opt for the Dividend Payout option, the dividends are tax-free in your hands, but now the fund house has to pay a dividend distribution tax @ 10% ( ~ 11.65% with surcharge and cess), which was earlier applicable only to debt funds.
What are the pros and cons of investing in a tax saving mutual fund?
– Tax exempt at all stages (assuming long term capital gains are within stipulated limit)
– Opportunity to get superior returns on investment compared to other tax saving instruments
– Option to get dividends when declared, while still staying invested in the fund
– Unlock the power of compounding in case the growth option is chosen
– Lock-in period of only 3 years (compared to Tax Saver FD – 5 years, NSC – 6 years, PPF – 15 years)
– Increases your exposure to equity market if you are totally risk-averse
– No guarantee on safety of capital or assured returns
– No premature withdrawal allowed unlike with some other tax saving instruments
Selecting the right tax saving fund
– Look at the fund expense ratio – lower the better
– Check the performance of the fund for the past 3-5 years
– If you can devote some time to research, opt for the Direct plan
– Try to invest in at least two tax saving funds – either lumpsum or via SIP
– Check portfolios of the funds to avoid investing in the same bunch of stocks