How Mutual Fund SIPs Help in Tax Saving?

Do you want to be financially stable? Almost all of us aim for the same goal. We want to own our dream house, buy our dream car, provide quality education for our children, and achieve early retirement. To achieve all this, only saving money wouldn’t suffice, you’ll need to invest your money to earn returns over time.  

Mutual Funds are becoming a popular investment choice among Indian investors. What makes them popular is the balance between risk and return. Within mutual funds, SIPs are the favoured approach, which allows you to invest a fixed amount at regular intervals. 

Moreover, SIPs offer an added advantage— SIPs can help you in tax-saving. Are you curious to know how? Let’s dive deeper into the blog to understand the tax benefits of SIPs.

​What is a SIP in a Mutual Fund?​

SIP in mutual funds stands for Systematic Investment Plan. It is a systematic approach that allows you to invest in mutual funds regularly, say monthly or quarterly. In this systematic route, you start by choosing a mutual fund scheme, a defined amount, and a fixed interval to invest your money.

Investing in SIPs keeps you regular and disciplined in investing. You can even open for an auto-pay option where a defined amount is automatically deducted on a predetermined date of the month. It is one of the best ways to become financially disciplined.

​How SIPs Help in Tax Saving?​

Who is willing to pay hefty taxes on their income? None of us, right? We’re continually looking for efficient ways to reduce our tax liability. Along with minimising the tax liability, our aim is to grow our money (investments), which could be achieved with the help of SIPs.

Tax-saving mutual funds are also known as Equity-Linked Savings Scheme (ELSS). Please note that not all mutual funds are tax-saving.

​What are ELSS (Equity-Linked Savings Schemes)?​

ELSS are a type of mutual funds that not only provide the opportunity for capital appreciation by investing but also offer tax benefits under Section 80C of the Income Tax Act in India. If you start an SIP in ELSS funds, then you can claim a deduction of up to Rs.1.5 lakh per annum. This will reduce your taxable income. 

ELSS funds have a lock-in period of three years, meaning you cannot redeem or sell your investment in these funds before the completion of this period.

​Benefits of SIPs in ELSS for Tax Saving​

Here’re the benefits of SIPs in ELSS to minimise your tax-liability and maximise your saving:

1. ​Staggered Tax Benefits: When it comes to tax deduction purposes, each SIP installment is considered a separate investment. This allows you to claim benefits annually over the duration of your SIP.
2. ​Reduction in Timing Risks: If you invest at regular intervals, you are reducing the risk of entering the market at the wrong time. This is beneficial when the market is volatile.
3. ​Discipline Saving: SIPs allow you to become financially disciplined, which also helps you in sticking to your tax-saving and investment goals systematically.

Let’s understand the benefits with an example.

Prateek is a 28-year-old software engineer. He is looking for tax-saving options that not only reduces his tax liability but also align with his long-term financial goals. He decides to invest in an ELSS fund through a SIP.

​Investment Details:

• Monthly SIP: Rs. 12,500
• Investment Period: 3 years
• Total Investment: Rs. 12,500*36 = Rs. 4,50,000
• Estimates Return: 12% annually (hypothetical)

​Tax Saving:

• Prateek can claim up to Rs. 1.5 lakh annually under Section 80C. In this case, the investment includes his SIP in ELSS.
  
• Over three years, he maximises his tax deduction, thereby reducing his taxable income.
  

​How to Start Investing in SIP for Tax Saving?​

Here’s a step-by-step guide to start investing in tax-saving SIPs in ELSS funds. 

Step 1: Financial Goal and Risk Tolerance

Before starting investing, it’s crucial to understand your primary financial objective, whether it’s tax saving, wealth creation, or both. Since ELSS funds invest in equities, they have moderate to high-risk levels. 

Understanding your objective and risk tolerance will help you find the best tax-saving mutual fund scheme for yourself.

Step 2: Research and Select the Right Tax-Saving Mutual Fund

1. ​Performance: Look at the fund's past performance. Remember, past performance doesn’t guarantee future results. You can compare it with its peers and the relevant benchmark.
2. Fund Management: Don’t forget to assess the fund manager’s experience and track record in managing ELSS funds.
3. Expense Ratio: Expense ratio is the fee charged by the funds managers for management.
4. Investment Strategy: Make sure that fund’s investment strategy aligns with your risk profile and financial goals.
   

Step 3: Decide the Investment Amount

Once you’ve done your research, it’s time to determine how much you want to invest monthly. While determining the amount, remember that you can only claim a deduction for investments up to Rs. 1.5 lakhs annually in ELSS funds.

Step 4: Complete the KYC Process

In order to invest in mutual funds in India, you need to be KYC (Know Your Customer) compliant. This involves:

1. Providing proof of identity and address
2. Completing an In-Person Verification (IPV)
3. Submitting a photograph and PAN card details

Since it's the digital era, many asset management companies allow you to complete the KYC online.

Step 5: Register for SIP

1. ​Online: Most mutual fund houses and investment platforms offer an online facility to start SIPs. You have to log in to your preferred platform, choose the ELSS fund, and opt for the SIP option.
2. ​Offline:  If you prefer the traditional route, you can visit the office of the mutual fund or your financial advisor. Fill out the SIP form, and submit it along with a cheque for the first installment.
   

Step 6: Link Bank Account and Set Up Auto-Debit

The next step of action is to link your bank account for the SIP and  set up an ECS (Electronic Clearing Service) mandate. This allows the mutual fund to auto-debit the SIP amount on the specified date.

Step 7: Monitor Your Investments

It is always recommended to review your portfolio at least once a year. This helps ensure that your investments are aligned with your financial goals and market conditions.

​Common Mistakes to Avoid with SIPs for Tax Saving​

1. ​Ignoring Investment Horizon: Don’t just invest for tax benefits. Also consider the long-term goal, especially since ELSS funds have a lock-in period but perform best over a longer duration.
2. Overlooking Fund Performance: Investing in ELSS funds for tax savings shouldn’t be the only goal. You must evaluate its performance, management, and strategy.
3. Neglecting Tax on Returns: Understand the tax implications on your SIP returns to know your actual gains.
4. Lack of Diversification: It is always suggested not to put all your eggs in a single basket. That’s why your investment portfolio should be diversified, and it shouldn't only focus on tax-saving SIPs.
5. Last-Minute Investing: Plan your SIPs early in the financial years i.e. April and May for well-informed decisions. Don’t make hasty investments at the end of the year.
   

If you avoid these mistakes, you can maximise the benefits of your SIPs in tax-saving funds. Are you a freelancer? Learn tax savings tips for freelancers in India in 2024.

​FAQs on SIPs and Tax Saving​

#1. How does investing in SIPs help in saving taxes?

Investing in SIPs of ELSS funds helps save taxes under Section 80C of the Income Tax Act. It allows you to claim a deduction up to Rs.1.5lakh per annum, which ultimately reduces your taxable income.

#2. Can I withdraw my investment in ELSS before three years?

No, ELSS funds have a lock-in period of three years meaning you cannot withdraw your investment. 

#3. Are the returns from SIPs in ELSS funds tax-free?

Returns from ELSS funds are subject to capital gains tax. Long-term capital gains over Rs. 1 lakh are taxed at 10% without indexation.

#4. How much should I invest in SIPs for tax saving?

That completely depends on your tax-saving needs and investment goals. The maximum deduction available is Rs. 1.5 lakh per annum under Section 80C.

​To Wrap it Up!​

If you invest in SIPs, especially in tax-saving mutual funds like ELSS then you get a dual advantage of wealth creation and tax-saving. Hence, it’s crucial to understand the SIPs, and the common mistakes to avoid. The key to successful tax-saving investment isn’t just choosing the right instrument but also in planning, consistency, and an understanding of the broader financial landscape. 

We always recommend investors to consult with a financial advisor to tailor their investment choices to their specific needs and circumstances. Happy Investing :)