While investments are important, investments with a tax-saving component can provide an extra edge to build wealth over time.
As the financial year comes to an end, it is not uncommon to see taxpayers scurrying around to find the best options to save tax. Either they are confused about the numerous options or just plain lazy. To add to the misery, unscrupulous salesperson and self-proclaimed financial experts often masquerade as fiduciary advisors, taking advantage of the impending deadline to sell products that have a high investment cost to unsuspecting investors.
Before we plunge into tax savings instruments, it is important to determine how much one needs to invest. Under Section 80C of the Income Tax Act, Rs 1,50,000 from the total income can be claimed as an exemption. Provident fund contributions, the principal amount of home loan EMIs, stamp duty and registration charges, insurance premiums, even tuition fees for children are eligible for this deduction. Therefore the first step would be to add up all the eligible deductions and then subtract it from the maximum exemption amount of Rs 1,50,000. The remainder is what you need to invest to claim exemptions.
Currently, there are many avenues open for an individual to invest and avail tax benefits, ranging from insurance schemes, National Pension Scheme (NPS), Public Provident Fund (PPF) and Equity Linked Savings Scheme (ELSS). However, it is extremely important to pick the right investment option based on your risk profile and current income as a careless investment could prove costly in the long run.
Investing through insurance
Many insurance companies offer an additional investment option on their policies. Many of these schemes are attractive because of the low premium and the high returns, as claimed by the companies. For starters, the whole point of insurance is to make sure that the policy-holder or the dependent’s financial needs are taken care of. Most plans with the investment option offer less life cover and modest returns. Secondly, according to the handbook of statistics released by the Insurance Regulatory and Development Authority (IRDA), the insurance industry on average has a persistency ratio of 58.54% in the 13th month which means out of 100, only 59 policies are renewed. The figure drops even further after the 61st month, the persistency ratio is as low as 22.48%.
Many Indians opt for traditional banking options like savings deposits, fixed deposits or even recurring deposits. The allure of these products is strong as they are considered extremely low risk and the returns are fixed. They are not linked to markets and hence aren’t volatile. However, the tax liabilities along with inflation can seriously dent returns. Not to mention, post-demonetisation, banks are flush with funds and may be looking to lower interest rates if they haven’t done so already.
One can also opt for PPF or the NPS. PPF provides a return of 8.1% per annum effective from April 2016 while the returns are completely tax-free. The investment is liable for tax exemption under Section 80C. Returns from NPS, on the other hand, are taxable at the time of maturity. While both can be excellent options, they are primarily considered as retirement options and at best long-term investments. The investments are locked in for long periods and may not be suitable especially for the Johnny-come-lately investor.
Equity Linked Savings Scheme or ELSS is a type of equity mutual fund with more than 65% of the portfolio contains equity holdings. Investments into ELSS funds are exempted under Section 80C, thereby giving the investor the dual advantage of tax savings and capital gains due to exposure in the equity market. It does have a three-year lock-in period which compared to the other options, is a short duration fund and offers both a growth and dividend plan.
This can be a good option for individuals with a moderate to high-risk tolerance and seeking tax benefits. Ideally, there is no age limit to start investing and the SIP route is the most recommended. ELSS can be a good starting point for the first time investor as it provides exposure to the market and the lock-in period will ensure fiscal discipline. Also since it considered as a long term equity fund, capital gains are not taxed. Lump sum investments can also be considered.
Finally, the best thing you could ever do is to check the amount remaining of the Rs 1,50,000 limit, divide the amount into 12 equal parts, pick a scheme matching your risk profile and income and just start a Systematic Investment Plan or SIP.
The tax benefits are as per the current income tax laws and rules and any other current applicable law. Investors are advised to consult their tax advisors before investing.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.