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Which equity funds are most tax-efficient?

Each year India has a new generation of taxpayers who are aloof to the Indian tax system and how it works. Also, every year the budget brings in changes in the tax regime making it even more difficult for first-time taxpayers to keep abreast with the new rules and regulations. Depending on the tax bracket one falls under, their income is eligible for a tax deduction. To understand if your salary is taxable you can refer to tax calculator, a free online tool accessible to everyone.

Section 80C of the Indian Income Tax Act, 1961 allows Indian taxpayers a tax exemption of up to Rs. 1,50,000 by investing in certain tax-saving instruments. In India, most taxpayers invest in conventional schemes like Public Provident Funds and Tax Saving Fixed Deposits (FDs). But these fixed interest offering schemes are facing a drought in investment as most investors are now shifting to a market-linked tax saving scheme called ELSS. 

What is ELSS?

An equity-linked savings scheme or ELSS is an open ended tax saving scheme that comes with a three-year lock-in and tax benefit. Unlike conventional tax-saving instruments like PPF and tax-saving FDs, ELSS does not guarantee capital appreciation. However, in the recent past ELSS has always outperformed all conventional tax saving instruments and delivered a minimum of 15% annual returns.

What distinguishes ELSS from traditional tax-saving instruments is that it doesn’t guarantee income generation. The reason behind this is that ELSS predominantly invests in equity and equity related instruments of large caps and select mid cap companies. The underlying securities of an ELSS portfolio consist of stocks whose market price fluctuates every day. 

How to make the most out of ELSS?

Here’s an example of how ELSS can help taxpayers bring down their gross taxable income –

If your gross annual income is Rs. 12 lakhs that means you fall under the highest tax slab where 30% of your overall income is taxable. You can bring down your gross taxable income by investing in ELSS. As per Section 80C, an individual can invest up to Rs. 1.5 lakhs per fiscal year in ELSS. By investing this sum in ELSS, investors can bring down their gross taxable income.

Start a monthly SIP in the ELSS fund

If you wish to inculcate the discipline of regular investing, consider starting a monthly SIP in an ELSS fund of your choice. One can either make a lumpsum investment in an ELSS scheme or opt for a SIP. A systematic Investment Plan or SIP is a simple investment approach that ensures that you save and invest a fixed sum at regular intervals in a mutual fund scheme of your choice. Investing in a tax saving scheme requires discipline and SIP can inculcate that discipline in the investor.

Once you automate your SIP transactions every month on the fixed date, the predetermined SIP sum is debited from the investor’s savings account and is electronically transferred to the ELSS fund. Investors receive units in quantum with the investment sum and depending on the scheme’s existing NAV. The NAV of the fund may go up or come down depending on how its underlying assets perform in their own space.

Investing at the last moment may not be a good idea as this will only cause panic and one may end up overinvesting. Starting a monthly SIP in ELSS is probably the best way to save tax. Investors can even refer to the SIP calculator to determine the estimated returns the scheme will generate at the end of its lock-in period.

ELSS is an equity-linked scheme that carries a very high risk profile. Please consult a financial advisor before investing.

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