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Everything You Need to Know About Tax Saving Mutual Funds
Even though “sharing is caring”, most of us prefer to share less with the tax man and add to our overall savings. The government allows taxpayers to legally save a portion of their taxable income up to a limit of Rs. 1.5 lakhs annually under Section 80C by investing in different financial products such as Equity Linked Saving Scheme (ELSS), Public Provident Fund (PPF), National Savings Certificate (NSC), tax saver fixed deposits, etc.
In recent years, falling interest rates of fixed return investments such as FDs have made Tax Saving Mutual Fund, also known as the Equity Linked Saving Scheme or ELSS a popular investment route. The premise of an ELSS is quite simple – an Asset Management Company (AMC) accepts investments from various investors and issues units of value equal to the investment made. The AMC then uses this capital to invest in various equity and equity derivatives in order to generate wealth for the investors either through capital gains or through dividend distribution. In the following sections we will discuss some key features of ELSS investments.
Features of Tax Saving Mutual Funds:
- Lock-in Period: All tax saving investments ranging from PPF to ULIP have a pre-defined lock-in period. Prior to completion of this time interval, your investment cannot be redeemed or switched to another scheme. In case of PPF, the lock in is 15 years with partial withdrawal allowed from the 6th year onwards, for ULIPs and tax saver fixed deposits, the lock in period is 5 years. ELSS investments on the other hand have the category’s shortest lock-in period of 3 years.
- Tax Benefits: Though there is no upper limit on the amount of money that can be invested in ELSS, only investments of up to Rs. 1.5 lakhs or less are eligible for tax deduction. Moreover, tax saver mutual funds belong to the group of EEE investments, which implies that the principal invested, the capital appreciation earned and the maturity amount are all exempt from tax. Moreover, any dividends distributed by the scheme are also tax free for the investor.
- Equity Investments: ELSS, as the name suggests, are equity-based schemes i.e. a major portion of the fund’s portfolio comprise equity investments and equity derivatives. However, most tax saver mutual funds do have the option of investing a smaller portion of their portfolio in debt and money market schemes. These investments provide a higher level of liquidity to the scheme and may also help control losses during equity market downturns.
- Open Ended and Close Ended Funds: ELSS funds can be either open-ended or close-ended in nature. In case of open-ended funds, the investor can invest in the scheme at any time and also exit as per his/her investment target or need. In case of open-ended tax saver mutual funds, the investor has to stay invested for at least 3 years (the lock-in period) but may redeem or switch his/her units at any time after that. Closed ended schemes on the other hand have limited time intervals during which they allow investors to invest or redeem/switch from the scheme.
Benefits of Tax Saving Mutual Funds
In recent times, equity markets have reached record highs in India which has increased ELSS returns and led new investor groups to invest in ELSS. However that’s not the only reason for the popularity of tax saver mutual fund schemes. The following are a few more reasons driving the popularity of ELSS in India.
- Flexible Investment Choices: Unlike most tax saver investment options, ELSS funds allow investors the flexibility of using multiple strategies. For starters, the investor can choose between lump sum and SIP investments. Additionally, the amount of money to be invested at one go can be as low as Rs. 500 or a much higher amount if one desires. Such flexibility is not available in case of most other tax saving investment options.
- Simplified Investment Process: Mutual fund investments require a specialised mutual fund account, which requires SEBI mandated KYC. Needless to say that the old paper-based KYC system was tedious and time consuming. Now this entire process can easily be completed online using the Aadhaar-based eKYC process and an investor can potentially get started with mutual fund investment in minutes. The easy availability of online transactions has expanded the reach of mutual fund schemes such as tax saver scheme significantly in recent times.
- Diverse Portfolio: ELSS funds are mainly focused on investing in equities and various equity-based investments. Thus, they are considered to be relatively risky investments, however, tax saver funds do have a number of diversification strategies in place with respect to market cap and sector bias such that the overall investment risk is minimised. This feature is not available in case of equity investments such as equity stock, which potentially offer comparable or higher returns.
- Managed by Experts: Mutual funds are managed by professionals who have extensive knowledge of capital/bond market and are supported by a team of experts who help identify and select the best from available investment options. Thus by investing in an ELSS, the investor can get the help of an experienced team capable of growing their investment.
- Flexible Redemption, Switching or Reinvestment: Investors are free to redeem their mutual fund investments, switch to a different scheme or continue to stay invested in their fund after the three year lock-in period expires. If investment in the same ELSS fund is continued, there is no minimum or maximum time limit during which the investor has to stay invested.
- Complete Transparency: By law, AMCs are required to publish key fund data such as portfolio information, NAV, valuations, expense ratios etc. on their website. Such data is freely available to investors as well as market analysts and other stakeholders. This level of transparency is not available with any other type of tax saving investments.