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Best Tax Saving Mutual Funds To Cut Down Your Taxes

Tax Saving mutual funds not only save on your taxes but also offer handsome returns on the investment. As a result, it has gradually emerged as an attractive tax-saving instrument, especially for young working professionals. But do you know all that there is about ELSS tax saving mutual funds? Here’s a guide to everything that you should know about tax saving mutual funds.

tax saving mutual funds

It’s tax-season and everyone is rushing to save on their taxes. Noor notices Rahul calculating furiously on a paper.

“What’s wrong?” She asks Rahul.

“Ugh, my tax planning is messed up! I was supposed to put Rs. 1,50,000 in my PPF account in 12 instalments of Rs. 12,500 each. But after my trip to Bhutan, since I didn’t have enough cash, I put a smaller amount. Now I have exhausted my limit of 12 deposits and I don’t know what to do now!” Rahul says exasperatedly.

“Interesting. Have you thought of investing in tax saving mutual funds?” suggests Noor.

“What?” exclaims Rahul, “There are mutual funds for tax saving purposes? Is mutual fund tax-free? Tell me all about it!”

What are Tax Saving Mutual Funds?

Mutual funds for tax saving are like any other mutual funds. However, what truly sets them apart is their tax-saving ability. This quality makes investments in top tax saving mutual funds eligible for deductions from the total taxable income under section 80C of the Income Tax Act of India.

Mutual funds for tax saving purposes fall under the category of ELSS (Equity-Linked Saving Scheme) funds. ELSS funds are diversified mutual funds that invest a significant share of the corpus in equity or equity-oriented securities. The remaining portion of the investment is parked in debt securities.

Did You Know? ELSS funds are quite transparent as investors can daily keep a track of their portfolio!

You may also like to read how to invest in mutual funds in India and How Does a Mutual Fund Work?

Key Features of Tax Saver Mutual Fund

tax saving mutual funds india

Here are the key features of tax saving ELSS mutual funds:

  • Investments in ELSS funds start as low as Rs. 500. Additionally, there is no upper limit on these investments (However, the tax deduction is only available up to Rs. 1.5 lakhs).
  • Long-term capital gains up to Rs. 1,00,000 through ELSS investments are exempted from taxation.
  • The lock-in period for tax saving mutual funds is 3 years from the date of investment, which is the least amongst all the tax-saving instruments. The same applies even to tax-saving SIP mutual funds.
  • ELSS funds serve a dual purpose of tax saving and capital appreciation. However, even the best tax saver mutual fund is subject to market risks.
  • Normally, ELSS funds are open-ended in nature.
  • Mutual fund houses offer the nomination facility for subscribers investing in ELSS funds.
  • Most ELSS funds levy an entry and exit load. This means that the subscriber has to pay a fee during the sale/purchase/transfer/redemption of the fund units.

Taxation of Tax Saving Mutual Funds in India

As ELSS mutual funds serve the purpose of tax saving, it is essential to understand the tax elements involved.

First, investments up to Rs. 1,50,000 in ELSS funds are eligible for deductions from your taxable income under Section 80C of the Income Tax Act. As a result, you may deduct the sum invested in ELSS funds from your total income to find your taxable income.

For example, an individual who earns Rs. 10 lakh per annum falls in the 20% tax slab. Thus, if he does not invest any money, he will pay tax amounting to Rs. 1,25,000 (5% tax on the initial 5 lakhs plus 20% tax on the remaining 5 lakhs - excluding education cess).

However, if he invests Rs. 1.5 lakhs in ELSS tax saving schemes, his effective income comes to Rs. 8.5 lakhs and as a result, his tax is reduced to Rs. 95,000 (5% on the initial 5 lakhs plus 20% tax on 3.5 lakhs - excluding education cess).

Second, tax saving schemes in mutual funds bear long-term capital gains tax. As a result, long-term capital gains amounting to Rs. 1,00,000 per annum accrued through ELSS investments are exempted from income tax. Beyond this cap, the gains are taxed at 10%.

Types of ELSS Tax Saving Mutual Funds

Types of ELSS Tax Saving Mutual Funds

ELSS Tax Saver mutual fund can be broadly classified into the following two categories:

  • Growth Fund
  • Dividend Fund

Growth Fund helps with long-term wealth creation where the growth in the fund’s value is re-invested into the fund.

Dividend Funds can be further categorized into Dividend Payout, Dividend Reinvestment. Under the former, the investor receives a tax-free dividend income. These dividends are declared when the fund registers excessive profits that are over and above.

On the other hand, in the case of the former, the dividends are reinvested as a fresh investment to add to the NAV. The investor receives the regular dividend even during the lock-in period.

Who Should Invest in Tax Saver Mutual Funds?

Individuals and Hindu Undivided Families (HUF) are eligible to invest in ELSS funds. Investing in ELSS mutual funds is highly recommended for those investors who have sufficient knowledge of the market and have a risk appetite.

Further, those who wish to invest their money, in the long run, should seriously consider parking their money in ELSS mutual funds. A safe investment horizon in the case of ELSS funds is five to seven years.

Additionally, young investors, who are currently in the initial years of their professional life and want to make long-term investments can also reap the benefits offered by ELSS tax saving mutual funds.

Did You Know? Through ELSS schemes, investors can save an amount up to Rs. 46,800 per annum on their taxes! (if you belong to the 30% tax bracket and invest Rs. 1.5 lakhs)

Major Advantages of Best Tax Saving Mutual Funds

Advantages of Best Tax Saving Mutual Funds

Under Section 80C of the Income Tax Act, ELSS can be considered the best tax-saving instrument as it offers the following benefits:

Shortest Lock-In Period

When compared to traditional tax-saving instruments such as Public Provident Fund (PPF), National Savings Certificate (NSC), and National Pension Scheme (NPS), to name a few, ELSS offers a lock-in period of 3 years, which is the shortest. Hence, in comparative terms, it also offers greater flexibility and liquidity.
There is something called short-term mutual fund you should read it

Higher Returns

Since the returns on ELSS funds are market-linked, it can give marginally greater returns than other tax-saving options. As ELSS primarily invests the money in equity-backed schemes, the returns are in line with average long term equity returns of 12%!

Dual Tax Benefits

Apart from offering a tax deduction of Rs. 1.5 lakh from your taxable income, ELSS funds provide additional tax relief. This comes in the form of partial taxation of the returns generated by ELSS funds as long-term capital gains up to the sum of Rs. 1,00,000 are exempt from taxation. Beyond this upper limit, the earnings are taxed at 10% of the gains.

Option for Monthly Investment

ELSS funds offer the convenience of investing through Systematic Investment Plan (SIP). Through tax-saving SIP mutual funds, one can invest as low as Rs. 500 per month in an ELSS fund, which is subject to increase through compounding.

Diversified Portfolio

ELSS funds are a group of diverse mutual funds that are managed by a fund manager. Hence, your capital is not invested in a single place and as a result of the asset distribution, the risk of losses is moderately minimized.

Other Benefits

In addition to the advantages mentioned above, other key benefits of investing in ELSS funds include:

  • Dividend ELSS funds offer a regular income even during the lock-in period.
  • Since these funds are open-ended, investors can park their money all through the year.
  • Investors are not required to have an in-depth knowledge of the market as these funds are managed by professional fund managers.

Limitations of Tax Saving Schemes in Mutual Funds

While ELSS funds come with a host of advantages, even the top 10 tax saving mutual funds have their drawbacks or limitations. These are:

Market Risks

ELSS funds park a significant portion of the corpus in equity or equity-linked assets, which are highly volatile. As a result, ELSS funds have a risk profile similar to equity-oriented mutual funds. Thus, ELSS fund investments have a risk component that cannot be ignored. Compared to tax saving mutual funds, government-backed alternatives such as NSC and PPF are considered to be safer.

Long Investment Horizon

Even though the lock-in period for ELSS funds is 3 years, they are capable of delivering good returns only if the holding period is at least 5 years. Thus, investors eventually will have to park their money for a longer duration either way.

Partial Redemption Not Allowed

Unlike some investment options such as Fixed Deposits, ELSS funds do not offer partial redemption. As a result, the amount that has been invested in the ELSS funds can only be withdrawn after the completion of the 3-year tenure.

Comparison Between Traditional Tax-Saving Instruments and Tax Saving Mutual Funds in India

Here is a table that compares ELSS funds to traditional tax-saving investment options such as 5-year Fixed Deposit, Public Provident Fund (PPF), National Savings Certificate (NSC), National Pension Scheme (NPS):

Tax-Saving Investment OptionELSS Mutual Funds5-year Fixed Deposit (FD)Public Provident Fund (PPF)National Savings Certificate (NSC) National Pension Scheme (NPS)

Lock-in

period

3 years5 years15 years5 years

Until superannuation

(at the age of 60)

Approximate Returns12%6.50 to 8.25%8 to 10%8%10 to 12%
Risk ProfileHighLowLowLowModerate
Tax on ReturnsPartially taxableYesNoYesNo


The Best Tax Saving Mutual Funds in India

Here is a list of the best tax saving mutual funds of 2019

Know how mutual funds are taxed.

DSP Tax Saver Fund

Launched on the 18th of January 2007, DSP Tax Saver Fund is an open-ended ELSS fund. The fund invests 98% of its corpus in Indian stocks, of which 68.02% is parked in large-cap stocks, 11.16% is parked in mid-cap stocks, and 9.97% is parked in small-cap stocks.
Here is an overview of the DSP Tax Saver Fund:

Fund HouseDSP Mutual Fund
Risk GradeAverage
Return Grade
Above Average
Minimum Investment (in INR)
500
Minimum SIP Investment (in INR)
500
Minimum Withdrawal (in INR)
500
Minimum Balance (in INR)
500

Let’s take a look at the fund performance for one-time investment*:

Period invested forAbsolute Returns (%)
Annualized Returns (%)
Category Average (%)
1 week-1.46--0.82
6 months10.31-5.71
1 year15.9015.906.90
3 years35.5410.659.58
5 years67.8810.918.57
10 years247.6813.2611.06
Since inception405.43
13.469.79

Let’s take a look at the performance for SIP investments*:

Period Invested for
Absolute Returns (%)
Annualized Returns (%)
1 year9.2317.46
2 year9.238.72
3 year13.818.57
5 year31.0310.74
10 year109.7714.17

*figures as of November 2019.

Motilal Oswal Long Term Equity Fund

Previously known as Motilal Oswal MOSt Focused Long Term Fund, Motilal Oswal Long Term Equity Fund was launched on 21st January 2015.

This open-ended ELSS fund invests 96.98% of its corpus in Indian stocks with 62.93% going to large-cap stocks, 22.33% going to mid-cap stocks, and 1.6% in small-cap stocks.

Here is an overview of the Motilal Oswal Long Term Equity Fund:

Fund HouseMotilal Oswal Mutual Fund
Risk GradeBelow Average
Return Grade
Above Average
Minimum Investment (in INR)
500
Minimum SIP Investment (in INR)
500
Minimum Withdrawal (in INR)
500
Minimum Balance (in INR)
-

Let’s take a look at the fund performance for one-time investment*:

Period invested forAbsolute Returns (%)
Annualized Returns (%)
Category Average (%)
1 week0.54--0.82
6 months12.87-5.71
1 year14.2014.206.90
3 years43.6412.809.58
Since inception83.5313.449.79

Let’s take a look at the performance for SIP investments*:

Period Invested for
Absolute Returns (%)
Annualized Returns (%)
1 year10.6220.16
2 year7.176.8
3 year12.357.7

*figures as of November 2019.

You would like to read, how to choose the best investment option

Final Thoughts

If you wish to enjoy the dual benefits of saving on taxes and gaining attractive returns on your investments, then tax saving mutual funds are perfectly suited for your needs. While these investments would reward you with handsome returns, they are riskier than conservative tax-saving instruments such as 5-year FDs, PPF, and NSC.

As a good practice, consider your options carefully and pick the best tax saving mutual fund that is in line with your investment horizon. Your ELSS investments are well suited for alignment with your long term goals such as your child’s education or retirement. However, remember that saving tax is merely an outcome of your investment choices and not a hard goal in itself. Prioritise your goals and needs, and act accordingly...!

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