Moving to New Tax System? Include mutual funds in your portfolio – Here’s why

Finance Minister Nirmala Sitharaman’s proposal to introduce a new optional tax system from FY20-21 has been the biggest talking point of the Budget 2020. The new system lowers tax rates in most income slabs significantly, but participating taxpayers will have to forgo a majority of tax deductions and exemptions.

The launch of the new tax regime will lead to a change in mind-set about investments. Traditionally, countless taxpayers used to invest in a host of tax-saving instruments that were not necessarily aligned with their financial goals and liquidity requirements. The new system will give them the freedom to invest strictly according to their risk appetite and liquidity needs so that they can meet their short and long-term financial goals on time.

They can also explore new investment avenues that do not involve tax-saving incentives and look beyond the fixed income instruments, especially the low-returns fetching tools like the Kisan Vikas Patra, tax-saving Fixed Deposits and the National Savings Certificate. That’s why taxpayers who will opt for the new regime from the next financial year should be well-advised to consider including mutual fund investments in their portfolios.

Opportunities to earn higher returns

Under the new tax regime, most of the tax deduction benefits are proposed to be abolished. So, for example, you would no longer enjoy tax deductions up to Rs 1.5 lakh under Section 80C of the Income Tax Act in the new tax system. It means investments like tax-saving FDs, Public Provident Fund, NSC, Sukanya Samriddhi Yojana, Senior Citizens Savings Scheme (SCSS), etc., will not be eligible for deduction benefit under the new tax system. However, returns efficiency and not tax-saving should be the primary objective of investing.

Check these figures. NSC and PPF currently offer an interest rate of 7.9% p.a. while the SSY fetches 8.4% p.a. and tax savings FD rates are mostly in the range of 6-7% p.a. Some of these fixed-income instruments are great tools to meet our long-term investment goals. However, taxpayers can also look for new additions to garner higher returns. Depending on your risk appetite and goal requirement, you can go for appropriate mutual fund schemes. For the low-risk long-term purpose, you can consider investing in debt schemes; for a high-return-long-term need, you may invest in various equity schemes, and for the short-term, you may want to invest in liquid funds (debt scheme).

Long lock-in requirement and low liquidity

There are long lock-in periods when you invest in small savings schemes like the PPF and NSC. PPF has a lock-in requirement of 15 years, whereas NSC has 5 years. These schemes also come with steep restrictions over premature withdrawals. As such, in the new tax system, you may also want to go for mutual fund schemes apart from fixed income instruments which do not involve a lock-in requirement after factoring in the applicable exit load.

Consider the tax efficiency

As already mentioned, under the new tax system, the deduction benefit under Section 80C will no longer be available, so interest on fixed-income investments will be taxed at the applicable slab rate. On the other hand, if you invest in mutual funds, you can save tax on the return on investment. The long term capital gains (LTCG) on debt mutual fund investments are taxed at a 20% rate with indexation benefit, so in the new tax slab rate, you can save tax if you fall in higher tax slabs. Similarly, the LTCG on equity mutual funds up to Rs. 1 lakh is tax exempted, and LTCG above Rs. 1 lakh is taxed at a 10% rate while the short term capital gains (STCG) are taxed at 15% rate. So, by investing in equity funds, you can save a significant amount in tax whether the investment horizon is for a short-term or long-term depending on your tax slab.

That being said, mutual funds are subject to market risks and the returns are not guaranteed; on the other hand, investment products like the PPF, SSY, SCSS, NSC, etc., are backed by the government so risk-averse investors may still find them attractive despite losing the tax efficiency. For others, mutual funds schemes are expected to become more attractive than before under the new tax system.

In conclusion, it’s critical to compare your tax liabilities under the existing and the new tax system before making a decision. And if you decide to go for the new system to cut down your tax burden, you must ensure that you keep investing and insuring according to your financial goals and responsibilities. Not investing and insuring just because there are no tax incentives attached to them could prove to be a costly mistake.

(The author is CEO, BankBazaar.com)

(Disclaimer: This is the personal view of the author)

Source: Financial Express