If you are an individual new to the investing world, chances are you have skipped considering tax and its consequences while zeroing out on your investment securities. For instance, an individual might feel content with a gain of 8-9% interest on a fixed deposit scheme. However, if the capital gains are fully taxable, which usually is, then the effective post-tax-returns even for the highest tax bracket is just 5.6-6.3%. This income might not be adequate for a middle class or upper-middle-class urban Indian investor who is trying to keep up with the inflation rate and grow their wealth simultaneously.
This is when mutual funds come into the picture. Mutual funds are one of the best tax-saving investment options available to investors. One such tax saver mutual fund is Equity-Linked Savings Scheme or commonly known as ELSS. Before going into detail of ELSS mutual funds, let’s understand the tax benefits of investing in mutual funds
Tax on equity mutual funds – These types of mutual funds have at least 65% of their corpus dedicated to equity and equity-linked securities. The minimum holding period for long-term capital gains or LTCG gains in equity funds is 12 months. Those units sold before one year are termed as short-term capital gains (STCG) in equity funds are taxed at 15% plus 4% cess. LTCG gains above Rs1 lakh is taxed at 10% + 4% cess. LTCG gains up to Rs1 Lakh are exempted from tax.
Tax on debt mutual funds – These types of mutual funds have at least 65% of their corpus dedicated to debt instruments such as corporate and government bonds, treasury bills, et. The minimum holding period for long-term capital gains or LTCG gains in equity funds is 36 months. Those units sold before 3 years are termed as short-term capital gains (STCG) in debt funds and are taxed as per the income slab of investors. LTCG gains are taxed at 20% with the benefit of indexation. Indexation helps to reduce the tax obligation on investors to maintain the purchasing power of the investor after inflation.
Tax benefits under Section 80C – Individuals invest in ELSS to qualify for a tax deduction of up to Rs1.5 Lakhs under s/c 80C of the Income Tax Act, 1961. ELSS funds are eligible for a 3-year lock-in period. Under ELSS mutual funds, the majority of the corpus is invested in equity and equity-linked instruments. An individual can save up to Rs46,800by investing in ELSS, provided he/she belongs to the highest tax bracket of 30%. However, an individual should note that Rs1.5 Lakh is an overall limit of all Section 80C instruments including Public Provident Fund or PPF, Employee Provident Fund or EPF, ELSS mutual funds, life insurance premiums, and National Savings Certificate or NSC.
Considering your personal financial goals, investment horizon, risk profile, you can select the perfect mix of debt and equity mutual funds for your portfolio. Also, you should not consider investing in mutual funds for the sole purpose of tax saving on your investments. Happy investing!