How I Help My Clients Find Tax-Efficient Alternatives to Liquid Funds and Maximize Their Returns

Why I Had to Rethink Liquid Funds for My Clients

A few months ago, one of my retired clients from Gurugram, a 62-year-old with moderate risk tolerance, called me with a genuine concern.

He had invested ₹30 lakh in liquid funds from April 2023, hoping for reasonable returns with minimal risk. But the tax changes introduced in Budget 2025 had left him worried. His concern was simple but serious:

“Taresh, these gains are now being taxed at slab rates. I want something more tax-efficient. What should I do?”

And that’s when I realized—this is a question that many of my clients, especially those nearing retirement or relying on fixed income, are struggling with. The recent shift in tax treatment of liquid funds has made them less attractive. The challenge now is to preserve capital, ensure liquidity, and reduce taxes—all at once.

So in this blog, let me share how I guide my clients to smarter alternatives that don’t just beat inflation, but also minimize tax outgo.

What Changed in Budget 2025 and Why It Matters

Before Budget 2025, debt and liquid mutual funds enjoyed indexation benefits if held for three years or more, with long-term capital gains taxed at 20% post-indexation. But now, capital gains on liquid funds are taxed as per your income slab, no matter how long you hold them.

For someone in the 30% tax bracket, this change is massive. A product that once felt “safe” now suddenly looks “inefficient.”

In my financial planning sessions, I often say: “Don’t just focus on returns—focus on what you get to keep after taxes.”

So if you’re someone like my client with ₹30 lakh parked in liquid funds, what can you do now?

Let me walk you through my top tax-efficient alternatives that I recommend to clients—and how they can work for you too.

1. Arbitrage Funds – The Best Kept Secret

Arbitrage funds have emerged as my go-to suggestion for clients who want low-risk and tax efficiency.

These funds exploit price differences between cash and futures markets to deliver returns. What makes them attractive is the way they are taxed:

• Long-term capital gains (held for more than 12 months) are taxed at just 10% after ₹1 lakh exemption

• Short-term gains (less than 12 months) are taxed at 15%

Compare this with your slab rate—if you’re in the 30% bracket, this could mean saving up to 20% in taxes.

The returns may range between 6-8%, similar to liquid funds, but the tax treatment makes a huge difference.

Real Client Insight: A retired couple I work with switched ₹15 lakh from liquid funds into arbitrage funds last year. They saved close to ₹90,000 in taxes compared to their earlier setup.

2. Target Maturity Debt Funds (TMDFs)

While they no longer get indexation benefits, TMDFs remain a good long-term investment option for my clients.

These funds invest in government securities or high-rated bonds that mature on the same date. If you’re planning for a fixed goal—say your daughter’s marriage or a sabbatical—these funds help lock in returns and reduce reinvestment risk.

I usually suggest matching the fund maturity with your goal timeline—for example, investing in a TMDF maturing in 2028 if your goal is in four years.

They may not be great for short-term liquidity, but they’re excellent for stability and goal planning.

3. Ultra Short Duration or Low Duration Debt Funds

If you still prefer debt funds and want something close to the liquidity of liquid funds, I recommend ultra-short or low duration funds.

These are slightly riskier but can provide better returns than traditional liquid funds. Some of these have consistently delivered 6.5-7.5% returns in the past few years.

But remember—taxation is still at slab rate, so these are more suited to people in lower tax brackets or those looking for SIPs for emergency corpus buildup.

4. Smart Use of Section 87A and Income Limits

Here’s a powerful strategy I apply for retired individuals or homemakers in my client base:

If your total income including capital gains is below ₹12 lakh, you could still enjoy a tax-free status under Section 87A.

So in such cases, staying in liquid funds or even conservative hybrid funds could still work well, especially if your annual withdrawal doesn’t push you beyond ₹12 lakh.

This is where customised cash flow planning comes into play. I design income withdrawal calendars for each retired client—matching their income needs with tax brackets and investment types.

Also read: How to Get Empowered: A Money Roadmap to Living a More Joyful and Meaningful Life with 10 Transformative Strategies

5. Use Family Members’ Accounts Strategically

If you’re in a high tax slab, you could consider investing in the name of your spouse, children, or parents who are in lower or nil tax brackets.

This can help split the income and bring down the effective tax liability.

For example, I recently helped a senior client distribute his ₹25 lakh corpus across three family members. As a result, none of them crossed the ₹12 lakh limit—and the entire investment corpus earned tax-free or very low-taxed gains.

6. Hindu Undivided Family (HUF) Route

Many people forget the power of the HUF structure in wealth management. An HUF is considered a separate legal entity, which means it gets its own ₹2.5 lakh basic exemption and ₹1.25 lakh capital gain exemption under equity taxation.

If you’re the karta of a Hindu family, this is one of the best tools to segregate investments and reduce tax.

I helped a young entrepreneur set up an HUF and start an arbitrage fund SIP under that entity. In just two years, this has become a parallel stream of low-risk, tax-efficient passive income for his family.

7. SIP vs Lump Sum: The Timing Dilemma

A lot of clients ask me whether they should invest as lump sum or via SIPs in these new alternatives.

Here’s what I suggest:

• For arbitrage funds, SIPs help average out returns and reduce market-timing anxiety.

• For TMDFs, lump sum makes more sense since you’re aligning with a fixed maturity.

• For senior citizens, staggered investments through monthly STPs (Systematic Transfer Plans) from a liquid fund to an arbitrage or hybrid fund works wonders.

It’s all about cash flow mapping and tax timing. That’s where a good financial-planner-gurgaon/" target="_blank" rel="nofollow">financial planner makes all the difference.

A Note on Liquidity

Liquid funds still have one major advantage—T+1 redemption timelines. That makes them ideal for emergency funds.

In comparison, arbitrage fund redemptions take T+2 days. So I usually keep a blend of both in my client portfolios:

• 3-6 months expenses in liquid funds

• Rest in tax-efficient instruments

Conclusion: The Right Mix for the Right Life Stage

Finding the right tax-efficient alternative isn’t about finding the highest return—it’s about matching your needs, risk appetite, and life goals with the right instruments.

In my journey as a Financial Freedom Specialist, I’ve seen how a smart shift in investment strategy—especially after major tax changes—can save lakhs in taxes over time.

It’s not just about investment. It’s about intentional planning.

If you’re confused about where to move your liquid fund corpus post-Budget 2025, take a moment to assess:

• Your income bracket

• Liquidity needs

• Life goals

• Family structure

And then work with a planner who understands your full picture—not just your returns.

Action Plan (My Recommendation)

Situation Recommended Alternative Tax Advantage My Note

• In 30% slab with >₹10L in liquid funds Arbitrage Funds 10% after ₹1L exemption Best for tax-saving
• Have fixed-term goal (3-5 years) Target Maturity Fund Predictable returns Match with goal timeline
• Emergency fund setup Liquid Fund + Ultra-Short Term Fund Easy access Use 3–6-month ladder
• Retired with income < ₹12L Liquid or Conservative Hybrid Fund Can be tax-free under 87A Tax smart cash flow is key
• Investing on family’s behalf Use spouse/parents/children’s name Bracket reduction Use for long-term planning
• Want extra tax entity Set up an HUF Separate tax identity Ideal for passive income investing