What Are Tax-Exempt Mutual Funds & How Do They Work?
5paisa Research Team
Last Updated: 30 May, 2025 12:26 PM IST
Content
- What are tax exempt mutual funds?
- How do Tax Saving Mutual Funds work?
- Tax Implications of Tax-Exempt Funds
- How to invest in Tax Saving Mutual Funds?
- Who Should Invest in Tax Saving Mutual Funds
- How Do I Find the Best Tax-Exempt Mutual Funds?
- How Do Tax-Exempt Mutual Funds Affect My Overall Tax Liability?
- Features and Benefits of tax saving mutual funds
- Tax Saving Mutual Funds ELSS vs PPF vs FD
- Conclusion
Tax-exempt mutual funds are investment funds that primarily invest in securities offering tax-free income, such as municipal bonds or tax-saving instruments. In India, ELSS (Equity Linked Savings Scheme) is a popular ELSS tax exemption option under Section 80C. These funds offer tax deductions up to ₹1.5 lakh annually and have a 3-year lock-in period. They work like other mutual funds, pooling investors’ money to invest in equities, but with added tax benefits. Returns are subject to market performance, and long-term capital gains above ₹1 lakh are taxed at 10%.
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Frequently Asked Questions
Equity Linked Savings Schemes (ELSS) are the sole category of mutual funds that offer tax benefits. These funds are among the various investment avenues that qualify for tax deductions under Section 80C of the Income Tax Act, 1961 (Old Tax Regime). Investors can claim deductions on investments up to ₹1.5 lakh per financial year in ELSS and other eligible instruments, thereby reducing their taxable income.
Equity Linked Savings Schemes (ELSS) are the only mutual fund category that qualifies for tax deductions under Section 80C of the Income Tax Act, 1961. Under this provision, individuals can reduce their taxable income by claiming deductions on investments of up to ₹1.5 lakh in eligible options, including ELSS.
ELSS mainly allocates its assets to equities, including large-cap, mid-cap, and small-cap stocks, with a minimum of 80% of the portfolio invested in equities. However, to enhance diversification, a small portion may also be allocated to debt instruments.
Make a comparison based on historical returns over 3, 5, and 10 years, along with expense ratios, risk-adjusted performance metrics, investment approach, and portfolio composition. However, it's important to remember that past performance does not guarantee future results.
In India, tax exempt mutual funds risk market volatility, interest rate changes, credit/default risk of underlying securities, and policy shifts. ELSS funds have a lock-in period and returns aren't guaranteed. Tax laws may change, affecting benefits.
Yes, you can switch between mutual funds, either within the same fund house or to another. It may trigger tax implications, exit loads, or lock-in restrictions, especially in ELSS.
Yes, the minimum investment for Equity Linked Savings Scheme (ELSS) is usually ₹500. There’s no maximum limit, however, only up to ₹1.5 lakh per financial year qualifies for tax deduction under Section 80C.
The amount may be less due to applicable exit load, taxes (like STT), or NAV timing mismatch—units are allotted based on NAV at the time your transaction is processed, not when you check it. Market fluctuations can also affect the final value.
No, you can’t claim tax benefits for the entire ₹2 lakh. Under Section 80C of the Income Tax Act, the maximum deduction allowed is ₹1.5 lakh per financial year, even if you invest more in a tax saving mutual fund like ELSS.
You can check where your mutual fund money is invested by reviewing the fund’s factsheet or monthly portfolio disclosure, available on the AMC’s website. It lists holdings, asset allocation, and sector exposure, giving transparency into where your money goes.
No, only Equity Linked Savings Schemes (ELSS) offer tax benefits under Section 80C. Other mutual funds do not qualify for tax deductions, though their returns may still be taxable based on holding period and type of fund.