Tax Benefits of Investing in Mutual Funds
In most cases, investors only think about the return on funds and rarely about the tax implications of their actions. Investments like Fixed Deposits (FDs), which are preferred by risk-averse investors, offer 8-9% returns. But the interest earnings from these deposits are fully taxable. This, in turn, reduces the ultimate earnings to only 5-6%, which is insufficient to keep pace with shooting inflation rate. Alternatively, the best mutual funds in India offer one of the highest returns on investments and are also very tax-friendly.
Here are the tax benefits of investing in the best mutual funds:
Typically, there are two ways to earn tax advantages by investing in mutual funds online. You can either choose to invest in Equity Linked Savings Scheme (ELSS) or opt for equity or debt mutual funds. Both enjoy specific tax exemptions under the Income Tax Act, 1961.
ELSS: ELSS are diversified mutual fund investments that have more than 65% of their portfolio allocation in equity. These mutual funds involve money in stocks of listed companies to meet your financial objective. The companies are diversified in terms of sectors and also concerning market capitalisation (small-, mid- and large- caps). Investments in ELSS up to ₹1.5 lakhs are exempt from taxes under Section 80C. It is important to note that ₹1.5 lakhs is the cumulative 80C exemption cap inclusive of eligible investments like Public Provident Fund (PPF), life insurance premiums, National Savings Certificate (NSC), and more. But in comparison to other tax-beneficial schemes, ELSS has a lock-in period of three years, which is one of the shortest in this category. Moreover, these funds are more transparent as compared to several other schemes. You know the constituents of your portfolio, daily Net Asset Value (NAVs), etc. NAV denotes the value of a mutual fund, which keeps on fluctuating according to the performance of the fund. This allows you to judge the performance of your investment. Additionally, with a minimum contribution requirement of only ₹500, ELSS is more budget-friendly for you.
Debt mutual funds: Debt mutual funds hold less than 65% of the total portfolio in equities. Long term capital gains on investments held for three years are taxed at 20% post indexation. Indexation accommodates the purchase price of assets such to incorporate inflation over the years. This shoots the purchase price while reducing the total profits on mutual fund investments. This, in turn, lowers the taxes by a fair margin as compared to other investments like bank fixed deposits and other small saving schemes. That said, capital gains on mutual fund investments held for less than three years, are added to the total income and taxed according to the applicable tax slab.
Summing up
Overall, mutual funds online are a cost-effective investment to diversify your portfolio over different asset classes and industry sectors. The best mutual funds in India provide attractive returns and offer significant tax benefits, with the shortest lock-in period. For wise investors, it is advisable to invest a fair share of their overall portfolio in mutual funds of their choice.