Noticing the profitable return on mutual fund investments is enticing. Regardless, the portion of your returns that goes toward tax is exasperating. But what if we tell you that you can claim a tax deduction on some of your investments? Yes, you can invest in mutual funds and relish tax benefits at the same time. Are you wondering how? Read further, as in this article, we have simplified tax-efficient investing with mutual funds.
A Look into Mutual Fund Tax Implication
When you invest in mutual funds, it is crucial to consider your tax bracket, investment horizon, and the type of mutual fund (equity, debt, or hybrid) to comprehend and plan tax-efficient investing. Before exploring tax-saving techniques, it is crucial to understand the circumstances and methods through which taxes are imposed on you.
Short-Term Capital Gains
When you sell your equity investments within one year of purchasing them, any returns you accumulate are known as short-term capital gains. The profits on these gains are taxed at 15%.
Long-Term Capital Gains
If you sell your equity-oriented mutual funds after a year, the returns you make are known as long-term capital gains. The profits above one lakh are taxed at 10%.
Dividend Tax
Starting on April 1st, 2020, the dividends earned from stocks are subject to taxation. Companies are no longer responsible for paying DDT (Dividend Distribution Tax). You may be obligated to pay taxes on your dividends if your dividend payments exceed a specified limit. All dividend earnings are now subject to taxation, with a 10% TDS rate applied if the dividend income exceeds Rs. 5000.
Tax-Efficient Investment Option
While tax implications can be maddening, tax-minimising strategies are relatively compelling. Along with offering a profitable return on your investments, these investments dampen your tax burden. We have discussed a few tax-saving strategies for you to optimize your investments.
Equity-Linked Savings Scheme
The Equity Linked Savings Scheme (ELSS) primarily invests in equity and equity-related instruments, offering the potential for higher returns. They have a lock-in period of three years, which is the shortest among tax-saving investments under Section 80C of the Income Tax Act of 1961. You can claim a tax deduction of up to Rs. 1.5 lakh and save up to Rs. 46,800 by investing in ELSS funds. ELSS combines tax benefits with the potential for capital appreciation, making it a popular choice for long-term investments.
National Pension System
The National Pension System (NPS) is a retirement savings scheme. While it is distinct from mutual funds, it offers a similar investment element. The Pension Fund Regulatory and Development Authority regulates NPS under the PFRDA Act 2013.
NPS allows you to invest in a mixture of equity, debt, and government securities, aiming to build a retirement corpus. Professional fund managers handle your investments. It offers tax benefits, making it an attractive long-term saving option. Nevertheless, NPS has certain restrictions, such as withdrawal limitations and compulsory annuitization of a portion of the generated corpus. It typically provides financial assistance during retirement years.
Public Provident Fund
The Public Provident Fund is a long-term savings and investment scheme offered by the government. It provides a secure and tax-efficient way for individuals to build their financial future. Investors can deposit a specified amount annually, and the returns are eligible for tax exemption. The PPF account has a maturity period of 15 years. PPF is a popular choice for conservative investors seeking a combination of tax advantages and steady returns.
Life Insurance
Life insurance is a financial contract wherein an individual pays a regular premium to an insurance company. In return, the insurance company provides life cover to the beneficiaries on the insured person’s demise. Policyholders do not pay taxes on the premiums paid, and the death benefits are typically tax-free.
Tax-Harvesting Strategy
Tax-harvesting involves selling stocks or mutual fund units to minimise your tax liability on capital gains, whether they are long-term or short-term. It allows you to counterbalance the capital gains from your equity investments with capital losses, resulting in a reduced tax burden. Additionally, it involves securing profits to ensure that your capital gains remain below the threshold of Rs. 1 lakh, enabling you to avoid paying taxes.
It permits shareholders to maintain their portfolio’s intended asset allocation while taking advantage of tax deductions.
On a Parting Note
In conclusion, investing in mutual funds can be both exciting and frustrating, considering the potential returns and tax implications. Comprehending tax implications and opting for tax-efficient investments like ELSS and NPS can help minimise the tax burden while offering attractive returns. Besides, applying tax-harvesting strategies can further enhance returns. Consequently, you can attain profitable returns on your mutual fund investments without being burdened by taxation policies if you strategically invest in them.
