The tax benefits of investing in mutual funds: What you need to know

Mutual funds offer countless advantages, such as diversification, professional management, easy online management, liquidity, and cost efficiency. But beyond these advantages, mutual funds also provide significant tax benefits, which make them an attractive option for investors looking to maximise their wealth while minimising tax liabilities. Understanding these tax advantages can help you make calculated decisions and strategically plan your mutual fund investments.

Equity Linked Savings Schemes (ELSS) and the associated tax benefits

One of the most significant tax benefits available to investors in mutual funds is the deduction under Section 80C of the Income Tax Act, 1961. This deduction applies specifically to investments in ELSS mutual funds.

• Tax deduction: Investments in ELSS are eligible for a deduction of up to ₹5 lakh per financial year. This deduction helps reduce your taxable income, which means you pay less tax overall.
• Lock-in period: ELSS comes with a lock-in period of three years. While this might seem like a limitation, it’s significantly shorter compared to other tax-saving instruments like the Public Provident Fund (PPF) or National Savings Certificates (NSC).
• Capital gains tax: Gains from ELSS are treated as Long-Term Capital Gains (LTCG).

This benefit makes ELSS funds one of the best mutual funds for investors looking to reduce taxable income while also pursuing higher returns through equity exposure.

New tax rules post-budget 2024: Are there any tax benefits?

For equity mutual funds, units held for more than 12 months were previously taxed at 15% for short-term capital gains (STCG) and 10% for long-term capital gains. However, post budget 2024, these units will now be taxed at 20% for STCG and 12.5% for LTCG.

The tax-free threshold for LTCG has also been increased from ₹1 lakh to ₹1.25 lakh, meaning profits below ₹1.25 lakh are exempt from tax. It could be wise to stay invested in mutual funds for over a year to benefit from the lower long-term capital gains tax.

Debt mutual funds will continue to be taxed according to the investor’s applicable income tax slab rate, regardless of the holding period.

Want to balance risk and optimise returns? Use an asset allocation calculator 

An asset allocation calculator helps you build a balanced mutual fund portfolio by assessing your risk tolerance, age, and investment tenure. This tool generates recommendations for distributing investments across equity, debt, and other asset classes, which means you get a well-diversified approach. You can also adjust parameters like your risk capacity and tenure to instantly get updated suggestions and create a more customised strategy.

In simple words, this free online tool simplifies the decision-making process and ensures that your investments are neither too conservative nor too aggressive.

Key takeaways

Investing in mutual funds offers more than just wealth-building potential. It also offers significant tax advantages that can reduce your overall tax burden. The key is to understand the tax implications of different types of mutual funds, i.e., equity, debt, or hybrid, and align your investment strategy accordingly. Most importantly, always consult with a financial advisor or tax consultant to leverage their expertise in structuring your mutual fund investments. Their guidance can help you make informed decisions and balance growth with tax efficiency.