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Tax Planning with Mutual Funds: Exploring the Benefits of ELSS Funds

As you start to grasp the reality of adulting, you will find that a large part of it is planning!

One important aspect of planning, at least with respect to financial planning – is understanding the importance of tax planning. The primary objective of tax planning is to identify how much income can end up being exempt from tax out of your total taxable income.

What is a tax-saving mutual fund?

As soon as you start earning, you will be required to look into budgeting for your taxes. In India, you can opt for Equity Linked Saving Schemes (ELSS), which are tax-saving mutual funds! This means that you can invest in these mutual funds and potentially reduce your taxable income. 

Isn’t that just music to your ears? 

Well, stay tuned because we’re about to dive into some of the key benefits of tax planning by investing in tax-saving mutual funds – 

Tax Benefits (Duh!)

  • Tax Deduction: ELSS funds are tax-saving mutual funds that offer tax deductions under Section 80C of the Income Tax Act of India. Under this Act, investors can claim deductions up to ₹1.5 lakhs in a financial year. Effectively, up to ₹1.5 lakhs can be deducted from your total taxable income. So, if your taxable income is ₹10 lakhs, and you invest ₹1.5 lakhs in a year under ELSS funds, then your taxable income for that year becomes ₹8.5 lakhs.
  • Lock-in Period: ELSS funds have one of the shortest lock-in periods among tax-saving investment options under Section 80C, with a mandatory lock-in of three years. While this means that you can’t touch this amount for the specified lock-in period, it does provide you with relatively easy liquidity (albeit with an early exit load!) and the opportunity to review your investments periodically.

Higher Potential Returns (Yay!)

  • Equity Exposure: Tax-saving mutual funds or ELSS mutual funds primarily invest in equity and equity-related instruments, equipping investors with exposure to the potential growth of the mutual fund market. Over the long term, equities have historically delivered higher returns compared to other asset classes like debt and hybrid mutual funds.
  • Professional Fund Management: ELSS funds are managed by professional fund managers who analyze market trends, research companies, and actively manage the portfolio. Their expertise can potentially result in superior returns and can generally also help you with your tax-saving and tax planning objectives.

Flexibility (Thank God!)

  • Systematic Investment Plans (SIPs): ELSS tax-saving SIP mutual funds offer investors the flexibility of investing through SIPs, facilitating routine and often automated investments of smaller amounts regularly. This systematic approach encourages disciplined investing and reduces the burden of a lump sum investment – and believe us when we say – discipline is crucial to your investment journey.
  • Dividend and Growth Options: Tax-saving mutual funds can offer you the flexibility to choose between dividend and growth options. Keep in mind that while the former can be suitable for regular income, the latter is a good growth option that can help you with long-term wealth creation through capital appreciation.

Diversification (Bring it on!)

  • Portfolio Diversification: ELSS funds or tax-saving mutual funds invest your money across various sectors and market capitalizations, resulting in a diversified portfolio. And as you already know – diversifying your portfolio will help you in reducing investment risks by spreading your investments across different funds.
  • Professional Risk Management: ELSS fund managers can be a God-sent! They actively monitor your portfolio and can help you take necessary actions to manage risks. Risk Managers analyze market trends, adjust the allocation accordingly, and aid in making informed investment decisions, which can help mitigate risks associated with equity investments.

Long-Term Wealth Creation (Phew!)

  • Power of Compounding: Tax-saving mutual funds or ELSS funds offer the potential for long-term wealth creation through the power of compounding. If investors stay invested for the long term, the returns generated are reinvested, resulting in an increased capital investment amount, ultimately leading to an exponential growth of wealth over time.
  • Inflation Hedge: ELSS funds have the potential to provide returns that outpace inflation over the long term. Historically investing in equities has often outperformed inflation – so, investors can potentially protect their wealth against erosion in purchasing power while also tax-saving!

Transparency and Regulation (No cap!)

  • Regulatory Oversight: ELSS tax-saving mutual funds are regulated by the Securities and Exchange Board of India (SEBI), which ensures investor protection and transparency. Remember, SEBI and the RBI are the two main financial governance bodies in India and any tax-saving mutual fund will be regulated by them. Fund managers are also required to follow SEBI guidelines, provide regular disclosures, and maintain transparency in the fund’s operations – all of which are necessary for you to be a well-informed investor.
  • Regular Reporting: ELSS or tax-saving mutual funds can provide periodic reports and statements to you, giving you a clear view of your investments, portfolio composition, and individual fund performance. This will allow you to track your investments and make informed decisions year after year.

All these factors contribute to the popularity (and necessity!) of tax-saving mutual funds in India.

Before we wrap up, we’ll leave you with a list of the top 5 tax-saving mutual funds in India today – 

  1. Tata India Tax Savings Fund
  2. Motilal Oswal Long-Term Equity Fund
  3. SBI Long-Term Equity Fund
  4. HDFC Taxsaver Fund
  5. Kotak Tax Saver Fund

The Indian mutual fund market has made provisions for you – the investor – to reduce your taxable income, while simultaneously accumulating capital and growing your wealth, and experiencing the equity market. 

It is literally a win-win-win!

FAQs

  • What is an ELSS tax-saving mutual fund?

ELSS funds are tax-saving mutual funds that offer tax deductions under Section 80C of the Income Tax Act of India. Under this Act, investors can claim deductions up to ₹1.5 lakhs in a financial year.

  • Is there a lock-in period for ELSS tax-saving schemes?

Yes. There is usually a 3-year lock-in period for ELSS tax-saving schemes.

  • Can I invest in an ELSS fund using SIPs?

Yes. You can opt for SIP investments with ELSS tax-saving mutual funds.

  • What are the return options for ELSS funds?

ELSS tax-saving mutual funds can offer you the flexibility to choose between dividend and growth options. The former can be suitable for regular income, the latter is a good growth option that can help you with long-term wealth creation.

  • Are ELSS funds regulated?

Yes. SEBI is in charge of regulating the ELSS tax-saving mutual fund options in India.

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