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It’s that time of the year again—the financial year is coming to an end and many realise they may have an opportunity to save on income tax by making investments before March 31. It is the last-minute and the challenge is finding instruments to invest in to save tax. Unfortunately, when investing at the last-minute, many do not even stop to consider whether investing for tax saving can become an opportunity for wealth creation.
It is no surprise then that in the scramble to invest in the first instrument they can find, many investing to save on tax lose out. Some fall prey to cold calls made by unscrupulous operators pitching tax savings and sign up for something that looks great when the caller is making a pitch but may end up underperforming and not meeting your expectations in the long run. And some get stuck with such dud investments for a long time. It is the price we pay for investing at the last minute and not having the time to read the fine print.
Clearly, tax planning and investing to save on taxes should not be left for the last-minute. Just like saving needs a disciplined approach, tax planning should be seen from the same lens. The first step to disciplined tax planning is to understand that all tax saving options are not the same. Based on your needs and risk profile, some are smarter than others because they bring more advantages and could deliver better returns. The bottom line is that tax saving does not have to an area where you are stuck with investments that generate sub-optimal returns or restrict liquidity. There is a way to save tax and build wealth.
How tax saving options can build wealth
Given the confusing array of tax saving options available in India under Section 80C of the Income Tax Act, most investors with limited financial literacy can get confused. So, how do you figure out the right way to tax saving that also builds wealth? Once you realise that the first step to effective tax planning is a disciplined approach the next step is figuring out the option that offers the highest possibility of returns.
Few investment options offer the kind of wealth creation opportunities that equity offers. Equity as an asset class holds the potential to beat inflation and generate long term wealth. According to market experts, given the current level of markets in India today, equities are very likely to outperform fixed-income instruments over the medium term of three to five years.
However, direct investments in stocks do not offer tax saving opportunities and requires investment discipline in the face of volatility that the average person does not often possess. This is not the discipline of saving which you must build if you are to create wealth, but the discipline of understanding stock markets and it comes from domain expertise. That is where mutual funds come in, because you can leverage the power of investing in equity but leave the expertise required for equity investing to the domain experts, for a small fee.
ELSS is perfect for tax savings and creating wealth
Equity Linked Savings Scheme (ELSS) funds are a perfect fit here. ELSS funds have all the advantages of mutual funds but also deliver powerful tax savings with a mere 3-year lock-in, the lowest amongst other tax saving instruments. ELSS funds primarily invest in equities and equity-linked instruments, cutting across the market in terms of sectors and market cap.
After deciding on a disciplined approach and deciding you are comfortable with the risk of investing in equity-based ELSS funds, the next step is evaluating liquidity. Instruments that offer the best liquidity options help you save taxes while at the same time providing access to your money at the earliest. This is to not to say that you should not stay invested for a long period to meet specific goals like investing in a home, for a wedding, your child’s education, etc. Investing over the long-term always generates better returns. It is rather about lock-in. The lower the lock-in period, the faster you can have access to your money when you may need them. The 3-year lock-in with ELSS funds may be a better option for most investors because your money is far more liquid than in other investments.
On the other hand, the 3-year horizon also provides fund managers the ability to deliver better returns through informed decision making because they can take long-term strategic decisions as opposed to short-term moves in response to investor behaviour during times of market volatility.
Then there is the financial discipline factor too that comes from investing in ELSS through Systematic Investment Plans (SIPs). SIPs are a major advantage for mutual funds since you can invest amounts regularly based on your financial goals. SIPs not only help you build a regular investment habit thanks to automated deductions from your bank account, but as you regularly invest you also ensure that your investments benefit from averaging during times of volatility.
You can also gain from the power of compounding, which is another great wealth creation mantra. When you opt for the growth option in ELSS funds you stand to benefit from the power of compounding.
Wealth creation can never be done by shortcuts. Through the power of ELSS you can ensure sustainable wealth creation by leveraging the power of disciplined investments while also gaining from tax savings that ELSS provides.
ELSS Investments are subject to a 3 year lock-in. As per the present tax laws, eligible investors (individual/HUF) are entitled to deduction from their gross income of the amount invested in Equity Linked Saving Scheme (ELSS) up to Rs.1.5 lakhs (along with other prescribed investments) under section 80C of the Income Tax Act, 1961. Tax savings of Rs. 46,800 mentioned above is calculated for the highest income tax slab. Finance Act. 2020 has announced a new tax regime giving taxpayers an option to pay taxes at a concessional rate (new slab rates) from FY 2020-21 onwards. Any individual /HUF opting to be taxed under the new tax regime from FY 2020-21 onwards will have to give up certain exemptions and deductions. Since, individuals/HUF opting for the new tax regime are not eligible for Chapter VI-A deductions, the investment in ELSS Funds cannot be claimed as deduction from the total income. Investors are advised to consult his/her own Tax Consultant with respect to the specific amount of tax and other implications arising out of his/her participation in ELSS.
Mutual fund investments are subject to market risks, read all scheme related documents carefully.