Tax Saving Mutual Funds

An explanation of what tax saving mutual funds are and how you can invest in them. Why are tax saving mutual funds better options than Fixed Deposits and other tax saving instruments like PPF, NSC or FD.

What are tax saving mutual funds?

If you are earning, taxes would be a thing you’d be trying to avoid with all your might. Here we are faced with a question, how to avail the 80C benefits in the most efficient manner?

The traditional 80C instruments for tax savings — such as Public Provident Fund (PPF), National Saving Certificates (NSC) and Fixed Deposits (FD) — prove slightly inefficient when you look at their returns in the context of the period your money is locked in with them:
• PPF locks in your money for 15 years,
• The NSC for 5 years, and
• An FD can lock in your investment somewhere between 5 to 12 years.

All this while only delivering a Return on Investment (RoI) equivalent to 8.7% p.a., 8.5% p.a., and up to 9% p.a. respectively. Compared to this, if you invest in Tax Saving Mutual Fund Schemes, you can avail tax benefits of section 80C while investing in the equity markets, which can not only give you potentially greater returns, but also demand a reduced lock in period of three years.

Tax saving instrumentPPF NSCFDELSS
Lock-in period15 years5 years5 to 12 years3 years
Returns8.7%8.5/8.8%Upto 9 %Potentially 10- 15%
Partial Withdrawal before lock in endsPossibleNot possibleNot possibleNot possible

What are Tax Saving Mutual Funds or Equity Linked Saving Scheme (ELSS)?

Equity Linked Saving Schemes, or ELSS, are like any other run of the mill mutual funds. They pool in money collected from the investors and further invest them in stocks of several companies, creating a basket of equities for their investors and minimizing the risk exposure due to the volatility of the stock market. But ELSSes have a slight edge over regular Mutual Funds, as they also serve as instruments for saving taxes under Section 80C of the Income Tax Act, i.e., any investment made into an ELSS would be tax-exempt to the tune of Rs. 1.5 lacs, every year.
They do have some shortcomings. Since you are investing in the equity markets, you are susceptible to market volatility. PPF, NSC, and FDs deliver certain returns, while there is no guaranteed amount of return on investments made in an ELSS. But the chances of low returns are typically low, so don’t let it scare you.

You also cannot withdraw your investment before maturity, like in regular Mutual Funds. So if you invest into an ELSS, you are locked in for a relatively period of three years, unlike in PPF, and FDs where you may be locked in for longer.

ELSS also help in inculcating investment discipline. You need to invest in them through a Systematic Investment Plan (SIP). A SIP is like an auto-debit facility on your account, which deducts and invests a fixed sum of money on a specific date every month automatically.

Types of ELSS:

Like Mutual Funds, an ELSS comes in two variants:
Dividend Option: This involves you receiving a regular dividend on the money invested by you. It is well suited for people who are investing with a goal of steady income from their investments. But the eventual returns in this option may be lower than that of the growth option.
Growth Option: Here, the dividend earned on your investment is not paid to you, but invested back into the fund, using it to buy more units of the fund. Because of this, the value of your investment can grow to be significantly larger. This is a good option for patient investors who are not looking for steady income, but aiming at maximizing their returns on investment.

Tax Treatment of ELSS:

Under the Income Tax Act, 1961, ELSSes are treated as investments eligible for tax exemption under Section 80C. Under the proposed draft of the Direct Tax Code however, they have been excluded from the ambit of tax saving investment instruments.
Unlike any Mutual Funds, the success of ELSSes is more dependent on the fact that they help the investors in saving taxes, and with lesser emphasis on their performance in the stock market. If they lose their treatment as the tax saving instruments, they may also lose interest from investors. Therefore, the future success of ELSSes is dependent upon the treatment they receive in the new Direct Tax Code.
Till the Direct tax Code comes out, we can only speculate But until then, ELSS will continue to be tax exempt, and investors will continue to invest in them to save taxes and maximize the returns on their investments.

Some ELSS to invest into as per Market Experts:

Following are the best ELSSs to invest into as per the experts:

Tax Saving Mutual Funds
DSP BlackRock Tax Saver Fund - Direct Plan - Growth
Aditya Birla Sun Life Tax Plan - Direct Plan - Growth
Aditya Birla Sun Life Tax Relief 96 - Direct Plan - Growth
Franklin India Taxshield - Direct Plan - Growth
Axis Long Term Equity Fund - Direct Plan - Growth
Reliance Tax Saver (ELSS) Fund - Direct Plan - Growth Option
IDFC Tax Advantage (ELSS) Fund - Direct Plan - Growth
Axis Long Term Equity Fund - Direct Plan - Growth
L&T Tax Advantage Growth - Direct Plan - Growth
Invesco India Tax Plan - Direct Plan - Growth

But kindly keep in mind that the said list of best ELSSs is not exhaustive as it keeps changing depending on the AUM and NAV of the fund.
The details of the said funds can be seen in the table given in the preceding section.
As discussed in the preceding paras, ELSS is an excellent investment option and you should definitely look into it if you want to maximize the returns on your investments made for the purposes of tax saving. Like any other investment option, it has its shortcomings but let them not scare you.

Do your market research, educate yourself about this wonderful tax saving instrument, START INVESTING!