A Systematic Investment Plan (SIP) is one of the prudent routes for retail investors to invest in mutual funds. An SIP permits you to make investments of a predetermined amount in mutual fund schemes of your choice on a periodic basis, i.e., monthly, quarterly, six-monthly, or yearly and assists to create financial discipline. You may know that mutual fund SIPs allow you to preserve and create wealth over a long time period, but did you know that through SIPs, you can also reduce your tax burden?
Section 80C and SIP mutual fund
One of the primary ways you can lower your tax burden is by claiming the Rs 1.5 lakh tax deduction under section 80C of the Income Tax Act, 1961. This section allows you to claim a tax deduction if you make investments in products that fall under this section. Investment products as per section 80C include Public Provident Fund (PPF), National Savings Certificate (NSC), Employee Provident Fund (EPF), five-year fixed deposit, and life insurance.
However, one major drawback of investment in such fixed-income products is they do not provide high returns and even come with considerably long lock-in periods. For instance, PPF comes with a lock-in period of 15 years with a current interest rate of 7.10% per annum (compounded annually) while bank fixed deposits come with a five-year lock-in with an interest rate in the range of 5% to 7% per annum.
Besides fixed-income asset options, there is a market-linked option like Equity-Linked Savings Scheme (ELSS) that falls under section 80C. Note that, ELSS is an equity mutual fund scheme that offers considerably higher returns and the shortest lock-in period compared to other section 80C options. In the mutual fund category, ELSS is the only mutual fund type that offers tax benefits.
The best part is that you can invest in ELSS mutual funds through the SIP route, which permits you as a taxpayer to plan your tax-saving potential as per section 80C every year. By investing through SIPs throughout a financial year, you can devise an appropriate tax plan to claim the highest deduction and simultaneously attain your second important aim of wealth creation.
SIP investment in ELSS mutual fund
Investment in ELSS through an SIP can allow you to make investments in a disciplined manner in the stock market, with a lower risk level and even offer tax benefits. Also, as mentioned above, ELSS allows you to save tax under section 80C and gain SIP benefits like rupee-cost averaging and compounding to reap higher benefits over a long time period. Remember that serving a three-year lock-in period is a must in the case of ELSS mutual funds to avail the tax benefit.
Planning out your SIP investment in ELSS not just allows you to get the advantage of tax deduction but even allows you to earn higher returns on your investment than fixed-income instruments that fall under section 80C. ELSS offers higher returns as a majority of your money is invested in equities that hold high potential to beat inflation by a wide margin over the long run. So, ELSS investment through the SIP route is indeed a good tax-saving option as it comes with the shortest lock-in period than other investments and has a high potential of generating reasonably high returns.