Does Investing in Mutual Funds help in Tax Savings?

The tax season is on, and chances are you would be fretting and comparing different tax saving investment options to best suit your needs.The more you save on tax, the less money you shell out of your pockets. Hence, tax planning is quite essential. With so many options available to an individual, investors often contemplate if mutual funds are the ideal way to go about to save taxes. In this blog, we’ll try to answer that question for you.

What are tax-saver mutual funds?

Tax-saver mutual funds are like traditional mutual funds with the added benefit of tax-saving benefits to the investors. The distinctive attribute of such funds is that they offer tax deductions of up to Rs1.5 Lakhs under Section 80C of the Income Tax Act, 1961. Let’s understand how mutual funds serve the purpose of saving taxes.

How do mutual funds save tax?

Individuals investing in mutual funds are offered with the 3 types of tax-saving options:

  1. Tax exemption – It is amount removed from the total gross income and includes long term capital gains or LTCG tax on equity funds, interest from tax-free bonds, etc.
  2. Indexation – It is beneficial in the long-term debt securities to profit from the inflated purchase price using the cost inflation index.
  3. Tax deduction – It is the amount reduced from the total taxable income through benefits of investments u/s 80C.

Different types of mutual funds that offer these tax benefits to its investors:

Mutual funds providing tax exemption – It is primarily offered in the long-term holding of the equity-oriented fund. Under equity funds, long-term funds are defined as those funds having a holding period of more than a year. All capital gains made after 12 months are termed as long-term capital gains. LTCG is taxed at 10.4% (including indexation and a 4% cess.) However, make a mental note over here that just the gains are exempt and not the principal amount.

Mutual funds offering tax deduction – Mutual fund tax-saver, Equity-Linked Savings Scheme or ELSS are the only mutual funds under s/c 80C that provide tax benefits for investors. The principal amount invested in these tax-saving mutual funds is eligible for a tax deduction of up to Rs1.5 Lakhs per annum. ELSS funds have a lock-in period of 3 years. However, one should note that all Section 80C investments are cumulatively eligible for this deduction.

Mutual funds offering indexation – Most mutual funds, especially debt-mutual funds,provide indexation benefits to the investors while computing the tax liability. Under debt funds, long-term funds are defined as those funds with a holding period of more than 3 years. All capital gains made after 36 months are termed as long-term capital gains and are taxed at 20% post indexation.

Mutual funds can act as a great way to save taxes on your investments. However, do not invest in mutual funds with the sole purpose of avoiding taxes. Keep your investment objectives, risk appetite, and investment horizon in mind before determining your investment portfolio. Happy investing!

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