This is how people are saving tax with mutual funds.

Andrew Williams June 29, 2018 Comments Off on This is how people are saving tax with mutual funds.
This is how people are saving tax with mutual funds.

Of the many tax saving options under Section 80C of The Income Tax Act 1961, tax saver mutual funds or Equity Linked Savings Schemes (ELSS) have the maximum wealth creation potential if you have a long term investment horizon. Tax saver mutual funds are equity mutual fund schemes which invest in a diversified portfolio of stocks with the objective of generating capital appreciation for investors over a sufficiently long investment horizon. Investors can get tax deduction of up to Rs 150,000 in a year from their taxable income by investing in Equity Linked Savings Schemes (ELSS) under Section 80C of Income Tax Act 1961.

Compared to other tax saving investment options like PPF, NSC, life insurance policies and bank or post office tax saving fixed deposits, the tax saver mutual funds has the potential of generating much higher returns. For example – in the last 5 years ELSS category average returns have been over 18% annualized (Source: Valueresearchonline.com) which is unthinkable if you invest in any other tax saving instrument.

Well, while returns are the most important criteria of investing, let us see how people are also saving taxes with mutual funds while earning decent returns.

By being disciplined: People are saving taxes by investing in tax saver mutual funds through SIPs as it help save small amountswhile inculcating a disciplinary trait in the investor. Whether the markets remain flat or volatile, the smart investor would not opt out of the track of SIP investment. Through monthly SIPs investors invest a fixed amount which they need to save in order to save taxes. For example – if you need to save Rs 120,000 in a year under Section 80C; you can start monthly SIP of Rs 10,000 in tax saver mutual funds.

Therefore, if you are investing in a disciplined manner, you will not have to worry at the last moment to invest for your tax saving requirements.

By avoiding market timing: Procrastination is an unwise option in mutual fund. Market ups and downs are inherent nature of the market. This is simply because a market situation can never be predicted and also because market corrections are inevitable and that the market rallies always follow corrections. The timing, however, is uncertain. People saving taxes with tax saver mutual funds prefer to invest through SIPs as they need not to worry about uncertainties.

By taking advantage of rupee cost averaging: people are saving tax with mutual funds by taking the advantage of rupee cost averaging. Consider saving a small amount regularly for a long term investment horizon, rupee cost averaging can even out any market ups and downs in the long term, allowing the investor to gain maximum benefits on his or her investments over a period of time.

By getting decent capital appreciation: By investing in tax saver mutual funds not onlypeople can save a maximum tax of Rs 46,350 in a year (applicable for FY 2017-18 for those in 30% tax bracket) on their investment of Rs 150,000, but also get decent return on their investments. Compared to other tax saving investment options, the tax saver mutual funds or ELSS mutual funds as category has given average return of over 18% annualized in the last 5 years (Source: Valueresearchonline.com) which is far superior than the returns you can get by investing in any other tax saving instrument.

By beating the inflation – We have seen how ELSS mutual funds as a category has given average return of over 18% annualized in the last 5 years. Therefore, the real return (return – inflation) of ELSS mutual funds have been quite highas in the last 5 years average Inflation Rate in India is at 6.68 percent from 2012 until 2018 (Source:http://www.inflation.eu/inflation-rates/india/historic-inflation/cpi-inflation-india.aspx)

By paying less tax on the returns – So far we havediscussed how people can save taxes upto Rs 46,350 by investing Rs 150,000 in a year under Section 80C of The Income Tax Act 1961. But did you know how the returns received from tax saver mutual fundsare tax efficient?

There could be two kinds of returns if you invest in tax saver mutual funds – Capital appreciation (long term capital gains or LTCG) and Dividend income.

Long term capital gains (LTCG): If tax saver mutual funds are sold after the lock-in period of 3 years from the date of investment, then it leads to long term capital gains. Long term capital gains received from tax saver mutual funds are tax free in the hands of the investor till the end of the financial year 2017-18.

However, Budget 2018 has introduced LTCG tax on equity and equity oriented mutual funds including tax saver mutual funds. As per the new rules, LTCG tax will remain tax exempt up to Rs 1 lakh per annum i.e. the new LTCG tax of 10% would be levied only if the LTCG of an individual exceeds Rs 1 lakh in aFY. For example, if your LTCG is Rs 130,000 in FY2018-19 then only Rs 30,000 will face the new LTCG tax.

Dividends: Dividends are profits returned by a mutual fund scheme to the investor. Mutual fund dividends are tax free in the hands of the investor till the end of FY 2017-18. However, Budget 2018 has introduced dividend distribution tax (DDT) at the rate of 10% on the dividends declared by equity and equity oriented mutual funds including tax saver mutual funds.

Despite the LTCG, tax saver mutual funds still remain your best investment instrument for long-term wealth generation.Even after a 10% tax on your long-term capital gains, investment in tax saver mutual funds has the potential to outperform returns from most other tax savings and investment options available in India. As per Valueresearchonline.com  data (as on 09 Mar 2018), the ELSS category annualized average returns has been 18.61%, 9.56% and 18.12%respectively for the 1,3 and 5 years period compared to approx 7.00% to 8.50% returns from other fixed earning tax saving instruments.

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