Should You Invest in Tax Saving Mutual Fund Schemes?

by Shreya Paliwal Mutual Fund Financial services

New versus Old Tax Regime

The New Tax Regime was introduced by the Government in the Union Budget of 2020. The New Tax Regime has more income slabs compared to the Old Tax Regime. The tax rates of different income slabs in the New Tax Regimes up to Rs 15 lakhs of annual income are lower than tax rates in the Old Tax Regime. However, you can avail of various deductions in the old tax regime and your net tax payable maybe lower in the Old Tax Regime depending on how much deductions you can claim.

In this article, we will discuss of deductions you can claim under the Section 80C in the Old Tax Regime and tax savings mutual funds, which are eligible for claiming deductions u/s 80C,

Section 80C

Section 80C of Income Tax Act allows investors to claim deductions from their gross taxable income by investing in certain tax savings schemes which are eligible u/s 80C. The maximum deduction in one financial year that you can claim u/s 80C is Rs 150,000.

Different tax savings u/s 80C

These tax savings schemes can broadly be categorized as, Government small savings schemes (e.g. EPF, VPF, PPF, NSC etc), tax saver Bank Fixed Deposits, life insurance plans (traditional and unit linked plans) and tax saving mutual funds. Government small savings schemes (PPF, NSC etc), bank FDs and traditional life insurance are non-market linked schemes, whereas tax saving mutual funds (ELSS) and Unit Linked Insurance Plans (ULIPs) are market linked schemes.

What is tax saving mutual fund?

Tax savings mutual funds or Equity Linked Savings Schemes are mutual fund schemes eligible u/s 80C for claiming deductions from your gross taxable income. ELSS is a diversified equity mutual fund scheme which has a lock-in period of 3 years. You cannot redeem your units of tax saving mutual funds or ELSS before the completion of 3 years from the investment date. If you are investing in ELSS through systematic investment plans (SIP), each ELSS SIP instalment will be locked in for 3 years.

ELSS invests across industry sectors and market cap segments. There are no market cap limits for ELSS. The 3 year lock-in period of ELSS allows the fund manager of these schemes to invest in high conviction stocks without the pressure of redemptions. This can help the fund managers to generate superior alphas for investors.

Why invest in tax saving mutual funds?

· You can claim deductions of up to Rs 150,000 from your taxable incomes by investing in ELSS. You can save up to Rs 46,800 in taxes by investing in ELSS.

· Historical data shows that equity as an asset class has the potential of giving superior returns over long investment horizon. Over the last 20 years (ending 31^st January 2023), Nifty 50 TRI gave nearly 17% compounded annual growth rate (CAGR) returns. This is significantly higher than the interest rates of Government Small Savings Schemes or tax saver bank FDs.

· Tax saving mutual funds is the most liquid investment option u/s 80C. All 80C investments have prescribed minimum investment tenures e.g. 15 years for PPF. The minimum lock-in period for non ELSS investment schemes u/s 80C is 5 years. Tax saving mutual fund schemes has lock-in period of just 3 years.

· ELSS is one of the most tax efficient investment options u/s 80C. Long term capital gains of up to Rs 1 lakh in a financial year in ELSS investments is tax exempt and thereafter, taxed at 10% + surcharge and cess thereafter.