Note to readers: Every year, our last date to plan for our income-taxes is March 31. Yet, despite knowing this, we procrastinate and postpone our income tax planning. But this financial year (2020-21) has been tough due to Covid-19 and many of us lost our incomes and jobs. While we hope for better times ahead for our readers, now is a good time to plan our tax-saving investments if we haven’t done it already. Our first story answered five crucial income tax planning related questions. The second story, here below, talks about the best five tax saving instruments. And the last instalment in this series, is about 4 most common mistakes we make while planning for our taxes.
It is good to complete your tax-saving investments early on or through the year. But most of us procrastinate and wait till the last minute. Moneycontrol personal finance answered five crucial questions on tax-planning. Now that your doubts are cleared, here are the five of the most favoured tax-friendly investments. Find out which one is most suited to you. Remember, your limit to invest in tax-saving instruments is Rs 1.5 lakh for income earned in 2020-21.
Public provident fund
The Public provident fund (PPF) remains one of the most popular tax-saving instruments. There is no credit risk because PPF is backed by sovereign guarantee. The interest rate is linked to government securities and is subject to quarterly review. At present, PPF offers 7.1 percent.
Though this product comes with a 15-year tenure, it allows intermittent liquidity. Thus there is scope for partial, premature withdrawal.
“Conservative investors looking to invest for long-term goals such as retirement planning or for saving for their children’s higher education should invest in the PPF,” says Vinayak Savanur, Founder and CIO at Sukhanidhi Investment Advisors.
What works: Partial liquidity, interest received is tax-free, carries competitive returns among fixed-return instruments.
What doesn’t: Partial liquidity comes with many conditions; change of interest rates affects on-going PPF investments also; long lock-in.
Bank fixed deposits and National Saving Certificate
Five-year tax saving bank fixed deposits and five-year National Saving Certificate (NSC) are popular options. You can invest in the NSC by visiting any post office across India and it offers an interest rate of 6.8 percent. The tax saving bank fixed deposits offer interest rates in the range of 5 percent to 6.9 percent. You can get quarterly or annual interest from your tax-saving bank FD, but NSC does not pay you any regular income. The interest rate is compounded annually but you get your full amount only at maturity.
“To fund short-term financial goals, investors in low income tax slabs can use NSC or tax saving bank fixed deposits with reputed banks,” says Ravindra Deshmukh, founder of Arthmitra Financial Services.
What works: Safety; reasonable pre-tax returns. Ideal for medium-term goals.
What doesn’t: Interest is taxable. Low prevailing interest rates in the economy are a dampener.
Equity linked saving schemes
An equity linked saving scheme (ELSS) is the only pure equity investment vehicle available in the Section 80C tax basket. This is a mutual fund scheme that invests at least 80 percent of its corpus in equities. All investments made in ELSS are subject to a lock-in of three years. “The three-year lock-in period helps investors ride short term volatility,” says Anup Bhaiya, Managing Director, Money Honey Financial Services. “In the long term, you have a chance to create a large corpus as investments in ELSS may deliver superior returns than any other fixed income option,” he adds.
Apart from giving you an equity exposure, one of the main benefits in of ELSS scheme is that you can invest through a systematic investment plan (SIP).
Make sure you choose a scheme that has given consistent returns over longer periods of time and not those that just look good in the recent past. According to Value Research, tax saving funds have given 13.72 percent returns over five years ended January 18, 2021.
What works: Equity allocation; offers SIP option, potential for healthy inflation-adjusted returns.
What doesn’t: Volatile in the short-run; not suitable for those with low risk appetite.
Unit-linked insurance plans
Unit linked insurance plans offer an investment plus insurance combination. These are schemes offered by life insurance companies and invest in stocks and bonds. They have a minimum lock-in of five years and are expected to deliver market-linked returns. They allow switching between bonds and stocks in a tax-efficient manner.
Also read: Mutual funds or ULIP: which is a better options?
“In the last three years, ULIPs have become cost-efficient. Though the tax-free nature of gains make ULIP an attractive investment, investors should not ignore that they enter into a commitment to pay the premium year after year, failing which their benefits stand compromised,” says Bhaiya.
Opt for ULIPs only if you have a long enough time frame – 15 years or more. Otherwise, you are better off keeping life insurance and investments separate.
What works: Various asset allocation options available; proceeds of ULIPs are tax-free, but subject to conditions.
What doesn’t: Despite the insurance wrapper, the cover might not suffice. Low liquidity.
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