Save tax and grow with mutual funds

A lot of us consider tax saving to be an annual investment exercise to save up to Rs 46,350 in taxes under Section 80C of Income Tax Act 1961. As investors, we never consider tax saving to be a means to grow with it and achieve our long term financial goals like retirement planning and children education and so on.

If you were to look at various investment options under Section 80C, likeemployees provident fund (EPF), public provident fund (PPF), life insurance policies, and tax saving mutual funds etc., tax saving mutual fundcan serve your long term financial goal needs in addition to saving taxes.

Investors looking at tax planning, tend to underestimate the importance of long term goal planning. Traditional investment instruments such as employees provident fund, public provident fund and life insurance policies are options investors usually associate with long term planning. The reason for this choice is the perception that they are risk free and safe for long term. The question we need to ask is, is it enough to meet our future needs? Can we grow with these investments?

Mohan aged 30, invests Rs 12,500 per month in a mix of PPF, EPF and life insurance policies assuming overall average annual return of 7.50%. At retirement, when Mohan is aged 60, he can accumulate Rs 1.69 Crores.

So what is the problem?

At its present value the amount may look impressive. But in the future how long will it last after Mohan’s retirement? Assuming 6% annual inflation Mohanwill get only 1.5% real return. Does 1.5% real return still look like stellar and sufficient for say, his retirement savings?

Hence, the above amount suddenly looks inadequate after taking post inflation returns into account.Mohan may be far away from retirement and have a few decades left. During these pre- retirement decades Mohanmay have made himself used to a certain lifestyles and ways of living. He may also want to maintain the same standards of living post retirement. The cost of living and other financial commitments, he may be able to put aside a small portion of his saving for his retirement. Hence, the small portion, which in itself is inadequate, has to earn substantial returns post inflation to meet retirement needs. How can this small amount generate substantial returns so he does not have to worry about saving big amounts for his retirement?

So what could be the solution?

The answer lies in figuring out investment options where Mohan can get returns that are higher than average of 7.5% on his investments. This is what will make Mohan’s retirement planning successful. If instead of 7.5% returns, suppose Mohan gets 12% average returns on his investments, then he can create a corpus of an amazing Rs 4.41 Crores which is more than 2.5 times of what he could get from the average return of 7.5% on his traditional tax saving investments.

And so what is the answer?

The answer is – is it possible for Mohan to get 12% return on histax saving investments?

Yes, Mohan can get this kind of return!

Mohan will have to look intothe investment option called tax saving mutual funds which are also known as equity linked savings scheme (ELSS). They are a kind of mutual fund, which work on the same principle as the rest of the equity mutual funds, and also provide tax benefits.

Tax saving mutual funds or ELSS Funds as a category has given over 19% annualized returns in the last 5 years (source: Valueresearchonline.com – data as on 14/2/18). Therefore, Tax saving mutual funds are capable of giving higher returns but being an equity fund, like all other equity mutual funds, tax savings mutual fundis also subject to market risk.

As an investor, if Mohan is looking at attaining specific goals like retirement planning or long term wealth creation, option of investing in tax saving mutual fundsand grow with it cannot be ignored or overlooked simply because historically equity markets has given over 12% annualized returns (Last 5 year Sensex and NIFTY returns – Source: Valueresearch Market Monitor as on 14/2/18)

Let us now take a more detailed look at tax saving mutual funds

What is tax saving mutual fund

Tax saving mutual funds orELSS schemes of mutual funds are diversified equitymutual fundswith lock in period of 3 years that qualifies for tax savings under Section 80C of Income Tax Act 1961, up to a limit of Rs. 150, 000 per annum.

You can invest in tax saving mutual funds in lump sum as well as through SIPs. At the beginning of the year, you can calculate the amount need to be saved for the FY basis your income tax slab and you can invest the same in 12 equal monthly instalments through SIP.

Long term capital gains earned throughtax saving mutual fundistaxed at 10% if the total capital gain in the year of withdrawal is over Rs 1 Lakh. No long term capital gain tax is payable if the total long term capital gain is less than Rs 1 Lakh.

Dividends paid by tax saving mutual funds are tax free in the hands of the investor but the scheme has to pay dividend distribution tax (DDT) @ 10% and thus it is a cost to the investor.

As we have already seen above that the returns generated via equity investments are higher than traditional options, hence, among all the tax investment options available under Section 80C, tax saving mutual fund make for a compelling choice.

With higher returns and ability to save even a small sum of money each month through SIPs, investment in tax saving mutual fundcan make your small savings grow into big amounts through time value of money and compounding returns.

Conclusion

If you are a young investor have a few decades lined up before retirement, then investing in tax saving mutual fundis not a daunting option. The higherreturns on equity investment aregenerated only when the investments are made for a long period of time. Investors with adequate risk taking ability can choose tax saving mutual fund and grow with it for meeting long term financial goals.

News Reporter