It can be said with a certain amount of authority that nobody really likes to pay tax. This is especially true for income tax, which has a direct impact on the amount of money you take home. So, if you fall in the highest tax bracket, you end up paying 30 per cent plus cess on your income. However, you can easily reduce your tax burden with astute tax planning. The thing is that tax planning in itself should not be your goal. Your goal should be to plan your taxes in such a way that you are not only able to increase your income in hand but also achieve your financial goals. From that perspective, there are two clear benefits of effective tax planning:
- You can reduce the amount of tax you pay on your income
- You can invest the money saved to generate investment returns
One of the best ways to do tax planning is to invest in tax-saving instruments. According to Section 80C of the Income Tax Act, 1961, investment in certain instruments allows you to claim a tax deduction and reduce your overall tax outgo. Each instrument is unique in terms of the lock-in period, investment returns, and withdrawal flexibility. A point to note here is that irrespective of the instrument or instruments in which you choose to invest, the combined deduction allowed under this section is subject to a limit of Rs1,50,000. That said, a favoured investment is tax-saving mutual funds or Equity-Linked Saving Scheme (ELSS).
What Is ELSS?
An ELSS is simply an equity mutual fund that offers the added advantage of tax exemption of up to Rs1,50,000 under Section 80C of the Income Tax Act. An ELSS mutual fund primarily invests in equity and equity linked investments as it is mandated to invest a minimum of 80 per cent in equities. Further, the lock-in period, currently at three years, is the lowest among tax-saving investments. Both these factors combined make ELSS a compelling instrument.
The three benefits derived from an ELSS investment are:
- Tax savings
- Potential to gain from equity investments
- Minimum lock-in period of three years
Tax-savings: Investment in an ELSS can be claimed as a deduction from your taxable income under Section 80C of the Income Tax Act, subject to a limit of Rs1,50,000.
Potential for long-term wealth creation: Equities are considered as long-term vehicles of wealth creation. Through an investment in ELSS, you have the opportunity to grow your investment value over the long-term.
Diversification: It is well-known that the key to building a robust long-term portfolio and reducing overall portfolio risk is to diversify your investments across multiple asset classes. However, simple asset class diversification is not always enough. You also need to diversify your investments within an asset class. This is especially true for equities which tend to be volatile in the short term. ELSS mutual funds help you diversify your equity exposure by spreading your equity investment across market capitalisation and industries.
SIP your way: You can easily start a systematic investment plan (SIP) in your chosen ELSS. An SIP enables you to invest a fixed amount of money at periodic intervals in the ELSS. This will also help you benefit from rupee cost averaging and the power of compounding while inculcating investment discipline.
Managed by experts: ELSS mutual funds are professionally managed by expert fund managers who follow a well-researched, systematic, and disciplined approach to investing.
Inarguably, tax planning is an essential part of your overall financial plan. It can help you reduce your taxes and invest the money saved to achieve your financial goals. With ELSS mutual funds you get the additional benefit of tax saving and potential wealth creation through equities. However, you must always keep in mind that ‘a stitch in time saves nine’. So don’t wait till the last moment to plan your taxes. Instead, start your tax planning journey early in the financial year so that you can holistically harness its true benefits.
By Dharmendra Singh Rathore, Managing Partner, Rmudra Ventures LLP