The IT Act does not treat all financial savings uniformly, and the taxability of contributions, accumulations and withdrawals differ from one instrument to another. Investments in a public provident fund (PPF) scheme, for instance, enjoy tax savings in the form of deductions, while the interest escapes the tax man's axe. The money you get on maturity is not taxable either. This method of taxation is referred to as the â€˜exemptexempt- exempt' (EEE) method since all three stagesâ€"contribution, accumulation and withdrawalsâ€"are exempt of tax.
On the other hand, while contributions to, and accumulations in, certain insurance products such as pension plans are not taxable, the amounts received by way of lump sum withdrawal or periodical pensions are taxable in the year you receive it, i.e., pension plans are governed by the â€˜exempt-exempt-tax' (EET) method of taxation. For example, for a bank fixed deposit that might give you a return of 8 per cent the effective post-tax return for someone paying 30.9 per cent tax would be a figure lower than inflation-a mere 5.5 per cent. Therefore, the question that comes to mind is: financial planning or tax planning? Should I be saving in banks or in share markets or in MFs? A proper financial planning exercise, making full use of the tax provisions, is what everyone wants.
Tax Benefits While Investing In Mutual Funds
Under Section 80 C of the IT Act 1961: If one invests in any of the specified instruments, his gross total income stands reduced by an equal amount, subject to a maximum of Rs. 1 lakh every year and tax is paid on the balance. For someone in the highest IT slab of 30.9 per cent, (including the education cess of 3 per cent which applies on tax plus surcharge) an investment of Rs. 1 lakh in one or a mix of Section 80C instruments reduces the individual's total taxable income by Rs. 30,900/-. For those with income above Rs. 1 crore, there is a surcharge of 10 per cent on tax payable in addition to education cess. Hence, for them the tax rate is 33.99 per cent. The list of specified instruments includes equity-linked savings scheme (ELSS), an equity-based MF scheme. As the name goes, ELSS is a savings scheme that is linked to equity. ELSS is a type of MF scheme that is formulated under ELSS guidelines and is similar to any diversified equity MF and routes investments into the equity market. However, it does come with some intrinsic features that differentiate it from other MFs. ELSS gives tax benefit on the amount invested and hence comes with a lock-in period of three years. One can invest up to Rs 1 lakh in a single or a combination of ELSSs.
There are two options to choose from in an ELSSâ€"dividend and growth. One can buy units under this scheme with a minimum amount investment of Rs. 500 and in multiples of Rs. 500 thereafter. Investments can either be in lump sums or through the systematic investment plan (SIP) route.
Investment in ELSS Scheme has a lock-in
period of 3 years. Considering the volatility
in the stock markets, it is better to invest
through SIPs, save tax and create wealth
over the long term. Typically, they are
known as tax plans, and can be bought
through intermediaries, such as banks,
distribution houses, brokers and individual
agents. One may also buy ELSS directly
from fund houses or from the Websites of
such fund houses. The entry load in ELSS,
as in any other MF scheme, is nil. The entire
investment participates in the stock market,
and based on the scheme's net asset value
(NAV), units get allotted. NAV is the
applicable net value of each unit on any
Using ELSS to meet goals
Put to use the tax benefit of ELSS to your advantage. Spread your investments in 2-3 ELSS for the sake of diversification across market capitalization and fund managers. Consider the long-term performance as against its benchmark, volatility, small-, mid- and large-cap exposure before zeroing in on a particular scheme. The pedigree of the fund also plays an important role. Don't buy or invest in a fund simply because its NAV is lower than its competitors. Keep financial goals in mind. Every ELSS adopts different stock picking strategies. Some schemes maintain a large-cap focus and are suitable for investors who have a low risk profile. On the other hand, funds that have greater exposure to small- and mid-cap stocks fit the portfolio of an investor willing to take some risk. Ignoring this aspect would mean a mismatch between the fund and the investor's profile.
If your ELSS investment made in the past is about to mature in the next 3-6 months, you need to decide carefully. Once you complete three years in an ELSS, review your investment. After all, one of your objectives (the tax deduction) has been met. Tax laws don't allow a rollover for claiming the Section 80C benefitâ€"they insist on fresh investments. Hence, evaluate your â€œmaturedâ€ ELSS investment as a normal equity investmentâ€"your decision to stay on or exit should be based on your perception of the market and the need for funds. You may reinvest proceeds in any other ELSS schemes. If there is a need for funds, you could liquidate some or all units. Remember, even partial units can be redeemed. However, if no such need exists, you may better postpone liquidation to few more months.
It is imperative to take advantage of equities to tackle inflation in the long run. An equity MF fits the bill as they come with a number of options to choose from. Volatility in the stock market will help generate wealth in the long run while tax benefit on returns can give your investment portfolio the much-needed edge. Therefore, take the MF route to meet your goals and say bye to tax worries!
CRISIL Research, a Division of CRISIL Limited has taken due care and caution in preparing this Report. Information has been obtained by CRISIL from sources which it considers reliable. However, CRISIL does not guarantee the accuracy, adequacy or completeness of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. CRISIL is not liable for investment decisions which may be based on the views expressed in this Report. CRISIL especially states that it has no financial liability whatsoever to the subscribers/ users/ transmitters/ distributors of this Report. CRISIL Research operates independently of, and does not have access to information obtained by CRISIL's Ratings Division, which may, in its regular operations, obtain information of a confidential nature which is not available to CRISIL Research. No part of this Report may be published / reproduced in any form without CRISIL's prior written approval.
This information is given for general purposes only. These views alone are not sufficient and should not be used for the development or implementation of an investment strategy. It should not be construed as investment advice to any party. All recipients / readers of this material should before dealing and or taking any decision of investment are advised to carefully review the Scheme Information Document and consult their legal, tax and financial advisors before making an investment decision. All opinions and estimates included here constitute our view as of this date and are subject to change without notice.
Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.