Category : New to Investing December 19, 20235 minutes read
Mutual funds are often the first choice of investors looking to gain attractive investment benefits plus tax savings. They can be the real game changer when it comes to saving tax. ELSS funds are a type of mutual fund used for tax benefits. We’ll explain the old and new tax regimes, mutual fund classification based on investment objectives, asset class, and other factors, and the mutual funds for tax benefits to invest in.
Introduction
Paying taxes is the duty of every law-abiding citizen. However, we all want to maximise tax benefits and the government of India has made this possible. While there is a proper set of instructions and guidelines according to the Income Tax Act 1961, in order to invest smartly under the income tax regime, it is essential to know its nuances.
You can create wealth while adding to your annual income tax savings by using mutual funds for tax benefits. While traditional instruments let you save on your taxes, mutual funds offer dual benefits tax saving and wealth building in the long term. We’ll walk you through everything you need to know about mutual funds for tax benefits, income tax regime, different types of mutual funds, classification of mutual funds, and more!
The Indian tax regime can seem difficult to understand for those who are new to it. To simplify this and improve compliance, the government introduced a new tax regime in the 2020 Budget. It came to save the Indian taxpayers from the burden of compliance. Further, it aims to reduce taxes, which modern taxpayers need. Read on to understand the old and new income tax regimes.
Old Tax Regime
The old Income tax regime was the only option available to taxpayers in India until 2020. Some of its key points are:
- It has over 70 exemptions and deductions covering House Rent Allowance and Leave Travel Allowance.
- Section 80 (C) of the old tax regime allows a reduction of taxable income up to Rs. 1,50,000.
New Tax Regime
The new tax regime was introduced in the 2020 Budget. It offers citizens more attractive tax slabs and lesser compliance burden. Here’s what you must know about the new tax regime:
- No exemptions and deductions like 80C, 80D, HRA or LTA.
- It allows a full tax rebate on income up to Rs. 7,00,000, and the tax exemption limit has been increased to Rs. 3,00,000.
- The new tax slabs are as follows:
| Sr. No. | Total Income | Tax |
| 1 | Up to Rs. 3,00,000 | 0 |
| 2 | Rs. 3,00,001 to Rs. 6,00,000, | 5% |
| 3 | Rs. 6,00,001 to Rs. 9,00,000 | 10% |
| 4 | Rs. 9,00,001 to Rs.12,00,000 | 15% |
| 5 | Rs. 12,00,001 to Rs. 15,00,000 | 20% |
| 6 | Above Rs. 15,00,001 | 30% |
A quick difference between old tax regime and new tax regime:
| Sr. No. | Old Tax Regime | New Tax Regime |
| 1 | No tax up to Rs. 2,50,000. | No tax up to Rs. 3,00,000. |
| 2 | Annual income between Rs. 5,00,000 to Rs. 10,00,000 was taxed at 20%. | Annual income between Rs. 6,00,000 to Rs. 9,00,000 is taxed at 10%. |
| 3 | Annual income above Rs. 10,00,000 was taxed at 30%. | Annual income between Rs. 9,00,001 to Rs.12,00,000 is taxed at 15%, Rs. 12,00,001 to Rs. 15,00,000 at 20%, and above Rs. 15,00,000 at 30%. |
Save Tax by Investing in Tax Saving Mutual Funds
Mutual Funds and Taxes
Typically, mutual funds are viewed as investment instruments. However, the government of India introduced mutual funds with tax benefits to encourage investment. They are like regular mutual funds, but allow for deduction under Section 80C of the Income Tax Act.
Mutual funds with tax benefits are also called Equity Linked Savings Schemes or ELSS. ELSS are mutual funds which allow tax exemption of up to Rs. 1,50,000 Under Section 80 (C) of Income Tax Act
Before we walk you through mutual funds under Section 80 (C), let’s discuss a little about mutual fund classification.
Mutual funds are investments that pool funds from different investors into different securities. They are professionally managed by asset management companies. These are excellent investment opportunities for individual investors. Let’s understand a quick classification of mutual funds based on investment objectives, asset class, and structure.
Different Types of Mutual Funds Based on Investment Objectives
1. Income Funds
These invest capital in debentures and bonds for fixed income to investors. Hence, these have fixed returns.
2. Liquid Funds
These invest the capital amount for a short or very short duration which doesn’t go beyond 91 days. These are short-term investments and have low associated risks.
3. Growth Funds
These aim to grow the investment capital in the long run. These invest special portions in shares and growth sectors offering potentially high returns and come with high associated risks. It consists of companies with above average growth and allows reinvestment of earnings into research, development, acquisition, and expansion.
4. Tax-saving Funds
These types of mutual funds for tax benefits are called ELSS or Equity Linked Savings Scheme. These offer tax deductions up to Rs. 1,50,000 annually under Section 80 (C) of the Income Tax Act, 1961.
Classification of Mutual Funds Based on Asset Class
1. Debt Funds
These funds invest in company debentures, government bonds, and other securities offering fixed income. Debt fund risks are comparatively lower among all mutual fund categories. Due to low debt fund risks, debt funds are preferred among investors with a low-risk appetite. There are no direct tax-saving debt funds, but they can help investors with total tax benefits.
2. Equity Funds
These invest in equity or stock and related instruments. These have higher return potential with significant risks with a recommended investment duration between three to five years.
3. Hybrid Funds
These allow investors to go for two or more asset classes based on investment goals and risk appetite. The different types of hybrid funds are arbitrage, debt-oriented, and equity-oriented debt funds.
Find suitable debt, equity or hybrid funds at Bandhan Mutual Fund and fulfil your investment goals.
Different Types of Mutual Funds Based on Structure
1. Close-Ended Funds
Investment in these mutual funds can be done during the New Fund Offer (NFO) period. These have low liquidity and offer redemption after fixed maturity.
2. Open-Ended Funds
Investment in these mutual funds are done throughout the year. Investment and redemption from open-ended funds are based on the current net asset value.
3. Interval Funds
These are a hybrid of close-ended and open-ended funds. The fund houses open funds for investing and redemption of units from investors if they want to exit during the interval period.
Introduction
Paying taxes is the duty of every law-abiding citizen. However, we all want to maximise tax benefits and the government of India has made this possible. While there is a proper set of instructions and guidelines according to the Income Tax Act 1961, in order to invest smartly under the income tax regime, it is essential to know its nuances.
You can create wealth while adding to your annual income tax savings by using mutual funds for tax benefits. While traditional instruments let you save on your taxes, mutual funds offer dual benefits tax saving and wealth building in the long term. We’ll walk you through everything you need to know about mutual funds for tax benefits, income tax regime, different types of mutual funds, classification of mutual funds, and more!
Mutual funds can be classified into 3 broad categories:
- Investment objective: Income funds, growth funds, liquid funds and tax-saving funds.
- Asset Class: Debt funds, Equity funds and Hybrid funds
- Structure: Close-ended funds, Open-ended and Interval funds
If you want to maximize the returns that you get from your tax investments, ELSS is one of the perfect options for a mutual fund for tax savings. These are equity-oriented mutual funds on which you can claim up to Rs. 1,50,000 annually as tax deductions under Section 80 (C) of the Income Tax Act. Since ELSS is a tax saving mutual fund under 80 (C) with a lock-in period of three years, it is essential to understand the tax benefits of its gains.
However, there are no special SIP tax benefits. There is a tax on SIP returns. Capital gains of up to Rs. 1,00,000 annually are tax-free, while returns of more than Rs. 1,00,000 annually are termed long-term capital gains and are taxed at 10%.
What is the Indexation Benefit of Mutual Funds?
Indexation is the process of adjustments to an asset’s purchase point to handle inflation between the time you’ve purchased it and sold it. Indexation benefit on mutual funds aims to reduce the tax burden on investors. It reduces tax on gains by adjusting the acquisition cost according to inflation.
Invest in ELSS Fund to save tax under Section 80C.
Mutual Funds for Tax Benefits- Salaried Class and Entrepreneurs
Investors looking for mutual funds for tax benefits can belong to the salaried class or entrepreneurs. Most Salaried employees already contribute towards the Employee’s Provident Fund or EPF, a fixed-income product that has tax advantages. Salaried employees aiming to earn high returns can invest in ELSS funds.
Investing in ELSS funds may suit salaried employees more than the unit-linked insurance plans (ULIPs) and the National Pension Scheme (NPS) as they provide market-linked returns. However, this is highly dependent on the investor and their risk-appetite and investment horizon.
Entrepreneurs can also invest in ELSS to get tax savings under Section 80 (C) of the Income Tax Act. It has a reduced lock-in period of three years when compared to other investment instruments for entrepreneurs looking for mutual funds for tax benefits.
- ELSS is one of the perfect options for a mutual fund for tax savings. These are equity-oriented mutual funds on which you can claim up to Rs. 1,50,000 annually as tax deductions under Section 80 (C) of the Income Tax Act.
- Indexation benefits on mutual funds aim to reduce the tax burden on investors.
- Most Salaried employees already contribute towards the Employee’s Provident Fund or EPF, a fixed-income product that has tax advantages. Salaried employees aiming to earn high returns can invest in ELSS funds.
While mutual funds are attractive investments, especially ELSS mutual funds, they do have some risks.
Types of Mutual Funds Based on Investment Goals
Following are the key types of mutual funds based on the investment goals, along with their advantages and disadvantages:
1. Tax-Saving Funds
ELSS offers dual benefits of creating wealth in the long term and tax savings for investors. These provide tax deductions up to Rs. 1,50,000 under Section 80 (C) of Income Tax Act. However, investors must stay cautious of ELSS risks and a lock-in period of three years.
2. Income Funds
Income funds also called debt funds divide the money into securities, deposit certificates, and bonds. These could comparatively offer better returns over other deposits. However, the earnings are lower than equity mutual funds and depend on the skills of the fund manager.
3. Capital Protection Funds
These mutual funds offer returns of up to 12% at best by protecting the capital amount.These have the lowest returns.
4. Fixed Maturity Funds
These funds invest in money markets, securities, and bonds, ranging from one to five years.Again, the returns depend on the skills of the funds’ manager.
5. Growth Funds
These funds allocate a special portion in shares and growth sectors. It suits investors with a surplus of idle money. It distributes money in riskier plans.
6. Aggressive Growth Funds
These mutual funds offer steep monetary benefits. It suits professional investors having detailed knowledge of financial parameters.It is highly susceptible to market volatility.
7. Liquid Funds
These debt funds come with a tenure of up to 91 days, with a maximum sum of Rs. 10,00,000. In liquid funds, the NAV of liquid funds is calculated for 365 days, including Sundays.
Before selecting mutual funds for tax benefits, let us have a quick look at the key points to consider before using mutual funds for tax benefits to prevent the possible disadvantages of investing in mutual funds.
8. Fund Size
Firstly, it is recommended to consider the fund’s size. It depends on the performance history of the funds.
9. Performance History
It is important to analyse the past performance history of the mutual funds and then select one for tax benefits.
10. Expense Ratio
It stands for the amount utilised in managing mutual funds. It is recommended to select mutual funds with a low expense ratio.
11. Goals
You must remain clear of your tax saving goals while selecting mutual funds for tax benefits. For instance, if you have a long-term goal of wealth creation while saving tax, ELSS may be suitable.
12. ELSS Risks
Like any other mutual fund, tax-saving ELSS is not risk-free. Investors must gauge the ELSS risks and then start investing in these funds for tax benefits.
13. Time Horizon
It is important to consider the lock-in period of three years while selecting ELSS mutual funds for tax benefits.
- Investors seeking mutual funds for tax benefits can consider investing in Equity Linked Savings Schemes. However, as an investor, you must be prepared to stomach market fluctuations.
- While investment in ELSS offers dual advantages of wealth creation in the long term and tax benefits to the salaried and entrepreneurs, and have the shorter lock-in period among other tax savers, they have no liquidation option before maturity.
- Now that you understand the nuances of mutual funds for tax benefits, income tax regimes, different types of mutual funds, and the classification of mutual funds in detail, you will be in a better position to make an informed decision.
