What Are Tax Saving Mutual Funds?

If you think mutual funds help generate wealth by offering substantial returns, that's not all they do. A certain type of MF also helps you save tax. Sounds unfamiliar? Allow us to weigh in! While it's true that returns from most MFs are taxable, the ones from equity-linked savings schemes present a different story.

We're not saying these funds are entirely tax-free, but you can claim a substantial tax deduction on them, the details of which are explained below.

What is equity-linked savings scheme (ELSS)?

Also called tax saving MFs, the equity-linked savings scheme invests its majority corpus in equity or equity-linked instruments. What makes this fund popular is that you can claim a tax rebate of up to Rs. 1,50,000 on it. You can file the exemption under Section 80C of the Income Tax Act (ITA).

This tax saving mutual funds comes with a mandatory lock-in period of three years. If you think this is a bothersome restriction, think again. Countless investors have found that this mandate has allowed them to inculcate financial discipline.

Anyway, market experts advise you to stay invested in this type of MF for at least 5 to 7 years. Why? Since these funds invest most of their stake in equity or stocks, they offer a moderate to high risk exposure.

To balance this out, a long-term investment is ideal. Several investors have observed that a long-drawn deposit in this MF offered them substantial returns compared to other tax-deductible instruments under Section 80C.

Additional Read: What Are ELSS Funds?

Features of equity-linked savings scheme (ELSS)

Before extending your financial portfolio to include this type of MF, make sure you know the following:

• This MF diversifies funds across different sectors and market capitalisations – small-cap, mid-cap, and large-cap. 

• Other than the lock-in period of 3 years, these funds have no cap on upper tenure.

• They invest a minimum of 80% corpus in equity-linked instruments.

• Investors don’t need to set aside a significant investible amount as several equity-linked savings schemes allow investments starting from just Rs. 500.

• After the lock-in period is over, you can redeem these units to receive long term capital gains on them. These gains are not taxable up to Rs. 1,00,000 in a financial year. After which, you pay a 10% tax on them. These numbers will readjust depending on whether you claim earnings from these MFs under Section 80C.

Additional Read: When is the Right Time to Sell Your ELSS Investment?

The bottom line

Financial experts consider equity-linked funds as a great way to dabble into equity MFs. Due to a 3-year lock-in, it provides you with an initial taste of market volatilities and risk factors. Often, investors gain valuable experience of the equity market through these funds and go on towards investing in high risk and return equity MFs.

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