One of the largest avenues of income for most governments is the taxes that it’s citizens are required to pay, in various forms. This income is then used to fund the development of the country in various areas. We should never consider income tax as a burden, but as an essential responsibility that helps move the wheels of the country’s economy.
The Indian government has many provisions that allow you to make investments of your choice to increase your wealth, and at the same time, help you cut a significant amount from your taxable income. Cutting down on taxes by making investments also has a number of benefits, which we shall discuss below.
Why should you incorporate tax-saving investments to your portfolio?
Incorporating tax-saving investments to your portfolio ensures that you have a head start on your financial future. A longer duration for your investments to grow not only means more returns for you when the investment matures, but also that you get them when you need them the most, which is towards the end of your career. The earnings from these investments that you make over a long period of time will help you cover for your expenses later in life.
The habit of planning your investments to save tax is also financially healthy because you tend to set aside a portion of your income in order to make investments, which can help protect your finances and future in the long run. Tax-saving vehicles also offer multiple other benefits apart from just helping you save your taxes. They are mostly long-term plans that build a corpus over a long period of time and help you meet your long-term financial goals, like retirement.
As already implied by the name, these are just like other mutual funds, but with an added benefit of saving taxes. The speciality of these tax saving mutual funds is that they make investments which provide tax redemption benefits under Section 80C of the Income Tax Act. Most of these Mutual Funds are Equity Linked Savings Schemes (ELSS) which investment into the equity market, and are growth oriented. They usually come with a lock-in period of around 3 years, which also helps you inculcate a good habit of investing.
How do they work?
When you invest in a mutual fund, your money is pooled into a larger fund. This accumulated capital is then invested into the equity market in a manner such that even if one of the investments incurs a loss, the other investments help mitigate the same.
The long term capital gains from these Equity Linked Savings Schemes are not taxed, and the investments made are eligible for a tax deduction of upto Rs.1.5 lakh.
Tax saving mutual funds make investments with at least 80% of their assets into equities. These mutual funds also allow you to invest all the year round, since these are open-ended in nature.
Schemes under the ELSS funds can be categorised into two section: dividend schemes and the growth schemes. The dividend schemes provide you an extra income as dividends from the fund house from time to time, depending on the availability of the surplus which is distributable. On the other hand, the growth schemes operate towards generating long-term returns that you can redeem upon maturity.
The dividends you derive from dividend schemes are untaxed, and can be withdrawn even during the lock-in period or can also be reinvested into the fund, making them eligible for tax benefits. However, the growth schemes under ELSS do not provide these benefits.
Benefits of these mutual fund schemes
The tax saving mutual funds provide you with multiple benefits, like making your investment eligible for tax benefits upto Rs.1.5 lakh. Furthermore, the capital gains that you make from these funds in the long run are devoid from taxes. You can also make investments in monthly instalments through SIPs, which would ensure that you do not incur a heavy financial burden while making the investments, and negating the need for a lump sum investment initially.
These funds are also highly diversified, which means that your investments are considerably safe from the market fluctuations because of the risk being spread across several verticals. Although you cannot withdraw the principal before the lock-in period ends, you can still choose to withdraw the dividends. Nevertheless, in case you choose to not withdraw the investment, it will form a substantial corpus which you can later utilise to fulfil your financial goals and needs.
Now that you have a fair idea of how you can save tax using mutual funds, and the benefits that they present to you, you can choose to make investments and start your financial journey. However, it is imperative that you always consider the opinions of your financial advisor before making any investment decisions.
