Most of us don’t think that actively about the income tax implications when we think about mutual funds. After all, we get what we’re looking for — a passive investment source that provides decent returns.. We don’t take the extra step required to understand the complications of income tax and how we can save on it.
But we should.
If we can reduce our tax liability while growing our savings at the same time, why shouldn’t we take that opportunity? Isn’t that what smart financial planning is all about?
Enter ELSS mutual funds — the perfect combination of tax-saving and wealth creation.
Before that, however, let’s take a look at what taxes are imposed on mutual fund investments.
How are mutual funds taxed?
Depending on the investment period, mutual funds are subject to capital gains tax. This will depend on the type of mutual fund.
Let’s explain.
For equity mutual funds, the STCG or short-term capital gains tax is 15%, and the LTCG or long-term capital gains tax is 10%. To qualify for the long-term rate, your investment period needs to be longer than a year.
For debt mutual funds, short-term tax is imposed at the existing tax slab, and the long-term tax is set at 20%. But, to qualify for the long-term rate, your investment period needs to be longer than three years.
There is an additional silver lining here. If your capital gains for the year are less than Rs 1 lakh*, then you don’t need to pay any tax on it!
Apart from that, mutual funds are also subject to dividend distribution tax. This is levied on any dividends that are paid out to the investors. For equity mutual funds, this tax is 10%, and for debt mutual funds, it is about 25%. Plus, you also get the benefits of indexation, which means the cost price is adjusted for inflation.
Don’t worry, though. The dividend distribution tax is deducted by the fund house directly before distributing to the investors.
How can you save tax using mutual funds?
To encourage people to invest more and take part in the capital markets, the government has introduced several tax benefits. These are associated with strategic payments for investment or insurance instruments.
If you want to save tax through mutual fund investments, ELSS mutual funds are the answer for you. ELSS, or Equity Linked Saving Scheme, offers investments in the stock market for the purpose of tax saving.
According to Section 80C of India’s Income Tax Act, you can actually get exemptions from your tax liability by investing money in specific financial assets and insurance. The maximum amount that you can claim is Rs 1.5 lakhs* each year. By investing this amount in ELSS mutual funds, you can deduct it from your tax liability.
In fact, no other mutual fund is eligible for exemption as per Section 80C. Apart from that, there are also other financial instruments like PPF, NSC and others.
Please note, you can invest as much as you want in ELSS mutual funds. But only a maximum of Rs 1.5 lakhs* will eligible for tax deductions.
ELSS Mutual Funds Explained
ELSS funds invest a minimum of 80% of the total assets under management in equity shares. The balance is spread out over debt instruments and cash equivalents.
These mutual funds offer you all the same benefits as normal equity mutual funds. The only difference is that ELSS mutual funds come with a lock-in. Once you make the investment, you will not be able to withdraw it for 3 years.
This means, even if you invest more than Rs 1.5 lakhs* per year, the maximum tax you’ll have to pay is 10%.
Tax Saving Tips for Mutual Fund Investors
First, make sure you claim the benefits under Section 80C. It may seem like a low amount right now, but it makes quite a difference while calculating your due tax.
Secondly, if you’re not able to claim the exemption or are over the maximum limit, make sure you opt for the LTCG tax rate. If required, you can work the longer holding period into your investment plan to make sure it is optimised.
Conclusion
The bottom line is — you can reduce your tax liability through strategic mutual fund investments. ELSS is a very smart investment asset, and has undeniable benefits!
*Source: https://www.bankbazaar.com/tax/deductions-under-80c.html
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Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
