Tax saving plans: Experts demystify the myths and truths

CNBC-TV18�s special show Informed Investor focuses on saving instruments and the the critical need for tax saving.

In an interview to CNBC-TV18�s Mitali Mukherjee, Jayant Pai, Vice President, Parag Parikh Financial Advisory Services (PPFAS) and Archana Bhingarde, CEO, Hi Q Financial Planners advices on the tax saving plans for a better and brighter future. Here is a verbatim transcript of their comments. Also watch the accompanying video. Q: Let me start with just the basic premise of the need for doing this for anyone? Pai: Tax savings has been the biggest motivator for most investments worldwide, so many a times governments have initiated a lot reform through this tax savings. So I guess it is a good way of getting people onto the right path. Because without that you may speak about things being good for you, but unless people pursue some tangible benefit, most of them will not take that first step. So tax savings is a good way to get going on some good steps towards financial planning. Q: Is there is a good thumb rule to work with over here? We talk so much in terms of what to invest in? What kind of returns to expect, for example from equities or FDs etc. But when you look at this whole tax savings phenomenon, is there is a quantum that one should look to save while investing XYZ amount? Bhingarde: Actually the government allows to invest Rs 1 lakh under the Section 80C . These investments are eligible for a tax saving. There is a thumb rule basically even as Jayant mentioned that is should be liked to your financial goals. Whether you choose equity or debt, it should be purely linked to your financial goals, so that you will stay invested. You will not wait that money to comeback and again rotate into the same kind of investments, but people will keep on doing this exercise throughout their life when they stick to their goals basically. Q: What kind of changes the direct tax code will have on someone�s savings plan or someone�s investment plan? Bhingarde: Basically over here whatever they invest under the Section 80C. If they invest into some kind of the equity investments take it Equity Linked Saving Schemes which is called ELSS by the mutual funds. All the dividends, which they earn, will be tax free even after 1 year. Of course there is a lock-in period of the three years for the equity investments, which is ELSS. All these investments are also free from the capital gain. But when they invest into the debt schemes like a five-year post office savings plans or five-years bank deposits. All these debt, whatever interest, which they earn will be taxable. When they invest into the LICs basically they take then insurance plans, that money, which is coming on a maturity will be tax free in the hands of the investors. Q: Let us pick it up with the debt schemes first. What are the debt instruments available right now for a retail or normal investor to invest in and what kind of potential savings does that throw up? Pai: Within the umbrella of section 80C there is Public Provident Fund, (PPF) there is also the Employee Provident Fund (EPF) in case you are eligible that will depend on whether the employer is a part of this scheme or not. There is also the five year tax saving bank deposits, other than that there are the post office saving schemes which are the NSE or the post office monthly income schemes. All these are under 80C. In most of these, these are fixed return instruments. For example in PPF you will get an interest of around 8% per annum which is recalibrated every year. In post office saving scheme, the rate may change but has remained stagnant at around 8% for a past few years. Similarly the tax saving deposits the banks will keep recalibrating the rates based on the scenario. Currently they are offering around 9.5 to10% for a 5 year deposit. These are some of the options within the debt arena. Q: Just to focus on FD a little bit � how lucrative it is this given the way rates are moving currently and the fact that for senior citizens actually the rate is even higher in terms of a return in FD? Is that slowly becoming the preferred option at least for this year or the next one? Pai: It is but you have to understand that if you are choosing the tax saving FD you are locking it for five years. Usually you are not allowed to prematurely terminate these deposits because there are certain court rulings which prevent ELSS schemes from prematurely being terminated. So I am presuming the same thing will extent to deposits too. In case you really have liquidity which you can spare for five years only then you should chose this and beyond that is a call on interest rates, if you feel that the compensation that you are getting in terms of locking a liquidity for five years is worth it then you should go in for it. Q: At this point in time between a debt equity mix would you say it is preferable to go towards greater debt exposure in terms of investment or saving? Bhingarde: it depends on the age of the investor and why is he choosing that. I prefer equities would be a good option because you have the liquidity after three years whereas your money gets locked in. Debt instrument for minimum five years because no debt instrument is below five years. In PPF your money gets locked for 15 years because you have a withdrawal facility available there but you have to choose according to your goals again. Q: There is one space that is slowly coming back into fashion and it wasn�t for a couple of years, the infra bonds � what would you recommend to be the approach over there? Bhingarde: Infra bonds fall under the debt instrument. They give you a fixed rate of return which has varied in this year from 7.5% to about 9.5% at the end of the year. The rate keeps on changing, the interest is taxable and they are offering it for five years period, 10 years and also seven years period.. Those who feel that they don�t need the money for a short while and the interest rates looks attractive, they lock the money into infra bonds for 10 years. Q: What kind of a mental makeup should one have while getting exposure to equity link saving instruments whichever form they maybe? Pai: Basically you should be attuned to equity. So that is the first thing. But even otherwise what I feel is that sometimes people are very hesitant towards equity but you if you throw in a tax saving angle people are willing to nibble. So usually financial planners suggest balance funds as a means to entering equity markets. But if not that even this equity links savings scheme have proved in the past that people who are taking their first steps within the equity space they are comfortable choosing this as a product. Q: Lets pick them up one by one then. The first one, which has been much, maligned over the last year or so the ULIPs. How would you describe ULIPs as a saving instrument and has it lost some of its sheen over the last 12 months? Bhingarde: Actually ULIPs can be considered as a good way of investing into the equity if your horizon is more than five years. But ULIP is solely basically by the agents to earn more commissions that should not be the focus but ULIPs and equity have delivered the return more than 12% who have stayed invested for more than five years into the ULIPs by the good companies. _PAGEBREAK_  The major players into this category are ICICI, HDFC, Birla. So it can be chosen only if you are you know that the money has to stay for more than 10 years and they definitely gave you the good returns along with the insurance cover which they are offering. Q: Is the new form in structure of the ULIPs actually more investor friendly right now and which one would you recommend from there? Pai: It is certainly more investor friendly in a sense that the agent will have a longer-term commitment towards you since the commission is spread equally over five years. And plus there is this norm of gross yield and net yield which is also supposedly in favour of the policy holders. However, I think going ahead once DTC is implemented again we could see a sea change in the popularity of these products. Since it has been stipulated that the policy should offer you a minimum cover of 20 times premium, in order to get the tax benefits so that will imply that these ULIPs which are already quite expensive there will be out of reach for most people if they want a tax benefit. I think going ahead its going to be term policies which are more in vogue from a tax saving angle. ULIPs are okay if you want that equity exposure but I believe that you can get a much cheaper exposure through mutual funds and combination of term end mutual funds. Q: Which brings us to a very active ELSS schemes - first, what do they mean? What kind of lock-in do they have and how does that work? Pai: ELSS is a product which has a lowest lock-in amongst all the tax saving instruments. It does a lock-in of 3 years only and other than that there is no difference between that and a normal diversified equity fund. So all the pros and cons of an equity fund will be present in this scheme and basically this belief that these are closed knit products and so they offer better returns, that myth has been exploded recently. So many of these funds are not really been managed to outperform regular equity funds. Anyway it�s a sunset thing because once Section 66 is implemented next year, I mean if it is going to be implemented in this form that they have outlined then ELSS will cease to be a tax saving product in the future. Q: Do you agree that it may not be the best or the most lucrative form of savings? Bhingarde: ELSS, yes. Because here the people can invest by the SIP more, in a systematic investment more so that�s the way they can get the benefit of cost averaging also. And those who are the first time investors into the equity market they can basically get into the equity by ELSS schemes and it also gives good returns as compared to the debt which is tax free also. Q: What would you say is the best form of equity exposure to take in that case. I mean between the ULIPs, between just pure mutual funds or vanilla mutual fund or some other instrument? Bhingarde: Direct taxes code will be implemented sometime later in this year. So we have to wait for the direct tax code to be published to come in front of the people. But according to what it is said like ELSS scheme will go away but still the people have the facility to invest into the equity by way of NPS that is the National Pension Scheme introduced by the government. That is a scheme which can also give you the exposure into equity, debt, balance whatever you wish to. So you still have that option open too and the amount available how much is the limit and all that will be available once it is published. Q: People tend to take equity exposure more based on what the equity market is doing rather than what is the most prudent time in their investment plan to be going about and putting in that money. What would you recommend in terms of a time horizon while taking equity exposure and when should you look to do it? Jai: As the all the experts say market timing is virtually impossible. But yet all of us try our luck in that and fail. So that�s what we advocate. Out of my own personal experience and even looking at the experience of others that I think the SIP is the best mode. It may not be a fool-proof mode but certainly it takes the guess work out of it and the discipline increases and other than that I think at least 5-6 year horizon is important. Because that�s usually the time of one up and down cycle which we have observed in India. So I think 5-6 years is a thumb rule and I think I will stick to that only.