KNOWLEDGE CENTRE Tax Planning / How to Save Income Tax by Investing in Mutual Funds?

How to Save Income Tax by Investing in Mutual Funds?

There are plenty of savings and investment instruments available in the market today. A few of these are tax exempt, and this tax exemption itself is an added saving as the amount of tax you have to pay is reduced.

Traditionally all tax savings investments have maintained their distance from equities and stock markets. Even today, there are only three options if you wish to make an investment in indirect equities as well as save tax.

The best tax saving option is Equity Linked Savings Scheme (ELSS). The other two are Unit-Linked Insurance Plans (ULIPs) and the National Pension System (NPS).

Below is a brief understanding of these three instruments. It will help you know how to save income tax more efficiently.

1. National Pension System (NPS)

NPS, as the name suggests, is a pension scheme that helps you save money for your retirement. Therefore, security is a major concern, which necessitates including debt within a fair share of the investment portfolio. Your contribution to the NPS account is invested in debt and equity. You may opt for active or passive management based on your personal choice.

The lock-in period of this scheme is until retirement. You may withdraw only when you are 60 years old. Even then, you are allowed to withdraw only 60% of the fund corpus. The balance amount has to be converted to an annuity.

As a tax-savings instrument, the investment you do in NPS is exempt under Section 80C of the Income Tax (IT) Act. The maximum deduction is INR 1.5 lakh per year. An additional INR 50000 invested in NPS is eligible for tax deductions.

However, the earnings thereof are not tax-free. The 60% that you can withdraw in a lump sum on maturity is a two-part fund. 40% is tax exempt whereas the balance 20% is taxed per your prevailing tax slab.

2. Unit Linked Insurance Plans(ULIPs)

This is first an insurance policy and thus, the premium you pay is first adjusted towards mortality and other charges. Thereafter the balance is invested in equities and debt depending on the option chosen. This reduces the earning potential of the amount that you have invested.

The investment in a ULIP is tax exempt under Section 80C and the returns are tax-exempt under Section 10(10D) of the Income Tax Act. The lock-in period of a ULIP is 10 years and these features make it a better option as compared to the NPS.

3. Equity Linked Savings Scheme (ELSS)

ELSS is neither a pension plan nor an insurance policy. It is purely an investment instrument and the best tax saving option. The lock-in period is only three years and you may withdraw the entire corpus whenever you want thereafter.

Unlike the ULIP, there are no tax deductions from the investment you make in an ELSS fund. The entire amount may be invested in an equity fund you choose. ELSS plans are EEE (exempt-exempt-exempt) schemes. This means your principal amount, the earnings thereof, and the maturity proceeds are all tax-free. Some of the best ELSS funds have time and again, outperformed the market and given excellent returns.

ELSS is an excellent investment option because:

  • The lock-in period is the shortest, only three years.
  • There is no obligation to include debts in the investment portfolio thus, making room for full earning potential through equity investment.
  • There is no mandatory requirement to retain a part of your maturity corpus and convert it to an annuity. You are free to use the maturity benefits as per your choice.
  • The returns are 100% tax-exempt post the lock-in period.
  • The return on ELSS funds is higher when compared to NPS because you can invest it all in equity. Compared to ULIPs, ELSS funds deliver better returns because there are no deductions from the investment amount towards insurance coverage. Thus, the entire principal amount earns returns over the investment tenure.

An even more lucrative option is to invest through a Systematic Investment Plan (SIP). This will give you the added benefit of the rupee cost averaging enabling you to earn better returns on your investments. Additionally, the regular smaller amount will be lighter on your pocket without creating any financial difficulties. It also inculcates financial discipline through regular saving habit and cutting down unnecessary or spur of the moment expenses.

Lastly, do not wait until the end of the financial year to start thinking about how to save income tax. It may not leave you enough time to carry out the necessary research to choose the right fund to invest in or benefit from the SIP mode. The sooner you start, the longer you can stay invested and earn higher returns. Start saving with the best ELSS funds today by downloading the Angel Bee app!

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