Mutual Funds For Tax Saving

Before the pandemic, not a lot of people thought about investing a portion of their income. However after March 2020, things has been changed. As working from home and lockdowns became the norm, people valued investing. As job security came under scrutiny for a lot of people, they realised the importance of investing. While some started investing in conservative schemes that were offered by banks, others started directing their investments toward the market.
Market-directed investments are considered by investors to be a smart investment choice as they are known to fetch them a revenue of a higher value yet with more risk To help with market investments, numerous investment tools/platforms are available. One of those tools is mutual funds and their numerous variants. One of the types of mutual funds is equity-linked savings schemes (ELSS). However, before learning about ELSS fund, let us understand how mutual funds work.

What are mutual funds?
A mutual fund scheme can be defined as an investment tool. In this investment tool, an AMC i.e., asset management company collects money from a group of investors and Once enough money is pooled in the fund, it is used to invest in different types of financial securities like stocks, gold, and money market instruments. By opting to buy a unit in mutual funds, you get to own a small stake in all the investments that are considered a part of the fund. Because of the numerous merits associated with these schemes, they are considered a prudent investment choice.

How do mutual funds work?
A organisation referred to as an asset management company (AMC) manages and operates mutual fund schemes and their different types. Each variant of mutual funds is known for having a specific investment objective that would cater to distinct investment needs. Depending on the fund’s objective, the money from the pooled fund is allocated to various securities such as stocks, gold, bonds, and other money market instruments. The responsibility of overseeing each fund falls on a professional who is referred to as a fund manager. A fund manager has one primary objective i.e. to to earn optimum returns on the fund’s investments. Once the scheme fetches income, the said revenue is divided and distributed among the investors proportionately.

Are there any merits associated with mutual fund schemes?

Mutual funds have tax benefits:
A major benefit of a mutual fund scheme is that its investors can avail of a tax deduction of nearly ? 1.5 lakh by opting for equity-linked savings schemes schemes (ELSS). Under Section 80C of the Indian Income Tax Act, 1961, investors can enjoy the tax benefits mentioned above. However, one major characteristic of this scheme is that they come with a lock-in period of 3 years. So, if you are thinking of opting for ELSS funds, it is possible for you to withdraw your money only after the end of the lock-in period. Apart from the tax benefits for ELSS, another benefit is the indexation benefit which is available on debt funds. In the case of traditional investment products, all interest earned is subjected to tax. However, with debt mutual funds, only the revenue earned over and above the inflation rate is subjected to tax. With the help of this benefit, one gets to earn post-tax revenue.

• They are affordable:
A major reason why many prospective investors hesitate to invest in the market is the notion that it might be expensive. While it is true that some investment schemes might be costly, the same can’t be said for an investment in mutual funds. The minimum initial investments for most mutual funds are affordable, ensuring that they are not a burden on the wallet.

They are known for a low expense ratio:
An expense ratio is known for measuring how much of a fund's assets are dedicated to administrative expenditures and other operating expenses. Because of the huge economies of scale, mutual fund schemes are known for having a low expense ratio. The operating expenses of a scheme include things like advertising-related expenses, management, administration, etc. Regulation 52 of SEBI Mutual Fund Regulations, 1996 has specified the limits of expense ratio for various types of schemes. A low expense ratio is another major benefit of mutual funds.

Mutual funds are also highly liquid:
Generally, mutual fund schemes can also be easily redeemed. Redeeming means- your investments can be easily liquidated if you need money for some financial emergencies. It is possible to redeem a mutual fund portfolio on any business day i.e., whenever the market is open. This means investors can easily access their money. After redemption of your investments, the amount will be credited into your bank account within 1 day or within 3-4 days. The number of days taken for the money to be credited into your account is dependent upon the type of scheme. If your funds are invested in liquid funds and overnight funds, the redemption amount is deposited into the investor’s account on the next business day. However, it is also important to remember that if you have opted for a close-ended mutual fund scheme, they can be redeemed only on maturity. Case in point, ELSS. These schemes are known for having a 3-year lock-in period and can be liquidated only after that.

They are known for being well regulated:
Another assurance of mutual fund schemes is that they are regulated by the capital markets regulator referred to as the Securities and Exchange Board of India (SEBI). In accordance with the SEBI (Mutual Funds) Regulations, 1996, the Securities and Exchange Board of India has established stringent rules and regulations regarding things like investor protection, transparency with an appropriate risk mitigation framework, and fair valuation principles.

It is possible to diversify mutual fund investments:
Diversification is a technique in which an investor’s invested funds are spread across different sectors and asset classes. By purchasing shares in a mutual fund, your funds are diversified across different securities and asset categories such as debt, equity, and gold. The technique of diversification helps in reducing the risk factor. Diversifying ensures that your money isn’t invested in a single asset class. Diversification proves to be advantageous when one of the assets of the mutual fund isn’t performing well but others are. In the diversification process, the risk associated with one asset class is countered by the others. It ensures that the investors don’t lose out on the entire value of their investment even if a particular component of the portfolio goes through a turbulent period. Thus, diversification of risks is one of the most salient merits of investing in mutual funds.

It is possible to enjoy the services of a professional:
To invest in the financial markets, firstly, you need to thoroughly research the market and you need to be knowledgeable about aspects such as company financials macroeconomy, and different sectors. If you are thinking about investing in the financial market, you are required to dedicate a significant amount of time and commitment. But, in case you don’t possess the skill or the time to carry out thorough research of the market, mutual fund investments may be an excellent alternative. Under the provision of these schemes, a professional fund manager takes care of your investments and attempts to provide you with a reasonable income for your investment. In return for the services provided by the fund manager, you are required to pay specific fees for the professional management of your portfolio. At regular intervals, a fund manager monitors a mutual fund’s investment and rebalances the portfolio accordingly to meet the scheme’s objectives. This is another important advantage of a mutual fund scheme.

More than one option is available:
As stated earlier, mutual funds are not a monolith, and they have numerous variants. Each of these variants is known to cater to different investment needs. For example, debt funds are known for investing in fixed income securities and equity funds are known for allocating funds to equities. Equity funds also have numerous types and one of these is equity-linked savings schemes (ELSS).

What is ELSS?
One of the numerous subcategories of mutual funds, ELSS plans are known for attracting investors who are seeking an investment tool that can offer them tax benefits. In accordance with the provisions of Section 80C of the Indian Income Tax Act, 1961, if your funds are allocated to ELSS, you can claim a tax rebate of nearly ?1,50,000. Through this claim, you can save up to ?46,800 a year in taxes.

How do they work?
In accordance with the name ‘equity-linked savings scheme’, fund allocation in this subcategory of mutual funds is primarily directed towards asset classes such as equity-linked securities and equities. Also, by opting to invest in ELSS, you get to invest in things like listed shares, and, apart from that, a small exposure to fixed-income securities may also be involved. However, before opting for this fund, you need to remember that equity-linked savings schemes have a lock-in period of three years.

What are the different benefits of ELSS?
Here are the different advantages of these schemes:

• You can enjoy tax benefits:
Amongst the many reasons why people opt for equity-linked savings schemes or ELSS is that it allows you get to enjoy tax benefits. These tax benefits are available because of the provisions of the Indian Income Tax Act, 1961 (Section 80C). By choosing to opt for ELSS, you may get to enjoy a tax rebate of approximately ?1,50,000 a year.

• ELSS does not have an upper cap on investments:
If you are thinking of allocating funds to ELSS, you can opt to invest any amount in the scheme. That’s because there are no limits on the sum that needs to be invested. But the minimum amount needed to invest in ELSS is known to vary across AMCs. Hence, while signing up for ELSS, make sure to check what is the minimum amount of investment for the scheme offered by a firm.

• The income generated may not be affected by inflation:
Other than saving taxes, another salient feature of ELSS schemes is that they come with the potential of offering inflation-beating revenue. For instance, you have opted to hold on to the ELSS scheme for 30 years. And, supposedly, after three decades, the market is experiencing inflation. Regardless of the market conditions, you need not worry as the income generated through the scheme may not be impacted by the conditions of the market.

• They can help in accumulating wealth in the long term:
When the lock-in period of three years ends, instead of redeeming your ELSS, you can opt to hold on to it. By opting to hold on to your ELSS, you can meet your financial goal, which is to have enough money at maturity when you approach the time of retirement.

Even though investors are generally known for opting for ELSS funds to save taxes, they can also use them to meet their long-term goals. As they use a multi-cap investment strategy, one can continue holding on to one’s ELSS scheme in case it is performing well.

Disclaimer -
*ELSS Investments are subject to a 3-year lock-in period and are eligible for tax benefit under section 80C of the Income Tax Act, 1961.

#As per the present tax laws, eligible investors (individual/HUF) are entitled to deduction from their gross income of the amount invested in Equity Linked Saving Scheme (ELSS) up to Rs.1.5 lakhs (along with other prescribed investments) under section 80C of the Income Tax Act, 1961. Tax savings of Rs. 46,800 mentioned above is calculated for the highest income tax slab.

Finance Act, 2020 has announced a new tax regime giving taxpayers an option to pay taxes at a concessional rate (new slab rates) from FY 2020-21 onwards. Any individual/ HUF opting to be taxed under the new tax regime from FY 2020-21 onwards will have to give up certain exemptions and deductions. Since, individuals/ HUF opting for the new tax regime are not eligible for Chapter VI-A deductions, the investment in ELSS Funds cannot be claimed as deduction from the total income.

Investors are advised to consult his/her own Tax Consultant with respect to the specific amount of tax and other implications arising out of his/her participation in ELSS'

Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.