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In case you are a salaried individual, this should be the time of the year when you could be busy submitting investment proofs in your office in order to save the income tax. Even if you are self-employed, this could be the right time to start tax planning before filing the income tax return for the current financial year.
Among the various-tax saving options, tax deductions under the Section 80C of the Income Tax Act,1961 are claimed most prominently. Section 80C allows both individuals as well as HUF to claim annual tax deductions upto a cumulative limit of Rs. 1,50,000 from their gross income.
There are multiple saving instruments available in the market which can be claimed for tax saving purpose under section 80C including PPF, ELSS, ULIP, NPS etc. However, such saving investment schemes vary from each other in terms of risk and reward, tax treatment, cost, ease of investment and transparency. Therefore, rather than making a random or popular selection just to save tax, it becomes important to understand policy terms of these instruments and make a conscious decision.
1. ELSS (Equity Linked Saving Scheme)
Lock-In: 3 years
Returns: 15-18% (Based on the last 5 years)
ELSS has emerged as one of the most popular avenues of investment for tax purposes under section 80C due to the impressive returns. So a tax rebate in addition to good returns seems a good deal to investors. ElSS funds invest at least 80% of the corpus in equity which means the returns are not assured and can be volatile. However, investing in ELSS can be highly rewarding from longer run perspectives.
ELSS funds have a lock-in period of 3 years after which you have the option to either withdraw your funds or continue with the investments.
If you compare returns on ELSS product for the last 3 or 5 years, it has consistently outperformed the returns from any other saving scheme. ELSS products have provided about 13-15% returns in the last three years and 16-18% in the last five years. Suppose, your income fall in the 30% tax bracket, you can make whopping returns compounded with tax rebate by investing in ELSS.
Taxability: While general investment in mutual funds is subject to 10% Long Term Capital Gains Tax (LTCG), ELSS investment come under the tax-exempt category under the section 80C.
Liquidity: Once you have served the mandated lock-in period for ELSS, they are one of the most liquid funds to be sold.
However, the challenge with ELSS is in selecting the right fund for you. Certain ELSS funds are more aggressive in their approach and have a comparatively larger investment in mid or small-cap stocks. While some other ELSS products play defensive by staying invested in large-cap stocks.
Also Read: Best ELSS Funds for Tax Saving
Therefore, it depends on your choice of risk-reward ratio. You have the choice to select multiple ELSS funds to diversify your investment. Also, it is not necessary that you must invest in the ELSS in one go. In fact, it is best that you invest in the scheme through SIP (Systematic Investment Plan) route.
Also Read: Best Performing SIP of 2019
Remarks: Investing in ELSS can be a great option to save your tax as well as get high returns on your investment. While ELSS returns are not guaranteed, you can hedge the risk associated with the ELSS investment by selecting good funds, investing regularly through the SIP route, and staying invested for longer-term.
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2. NPS (National Pension System)
Lock-In: Till the age of 60 years.
Returns: 11-13% returns (based on last 5 years)
While making your investment decision in order to save your income tax, If you are interested in having an extra slice of the pie, NPS could be an option for you as NPS can help you in saving your tax under three different sections.
Firstly, you can claim general tax-deductions upto Rs.1,50,000 under section 80C, then you can claim additional deductions upto Rs.50,000 under section 80 CCD(1b) by investing only in NPS. Further, if the employer agrees to put 10% of your basic salary in your NPS account, that amount also will not be taxable.
In addition to that, NPS is a no cost, no frills market linked product, which minimizes the risk by diversifying a part of investment towards more secure options like corporate debt and government security. Where the active fund managers in India charge a fee ranging 1-3% a year to manage your investments, NPS provides that service at 0.01%.
While NPS seems to be a better alternative to ELSS funds, given its low-cost structure and compatible returns along with additional tax rebate, one should be careful to a few things while investing in NPS.
First, investing in NPS is a tedious task in itself. First, you need to select whether you want to invest in Tier I or Tier II of NPS. They differ in terms of withdrawal limitations and taxability. Then the subscriber needs to select one fund manager out of the eight available options.
Then you need to decide your asset allocation and distribution preference between equity, corporate bonds, government securities, and alternative investments like investments in REITs, AIFs etc. You can allocate upto 75% of your investment towards equity. Then you need to select between Active or Auto investment choice. This way, it becomes difficult for an ordinary investor to subscribe to NPS in an informed way.
Secondly, the existing structure of NPS drastically limits the usage of your maturity proceeds. Unlike EPF or PPF which allow the investor to use their accumulated retirement corpus in any manner, the NPS obligates the investor to use 40 per cent of his proceeds to buy annuity plans. Further, the returns from the annuity plan/pension are treated as income and therefore, are fully taxable.
Finally, NPS limits the possibility of early withdrawal as it allows you to withdraw the funds on retirement only, except in certain exceptional circumstances on pre-specified grounds. However, It should not be a problem for a subscriber looking to create a long term retirement fund.
However, despite these complexities, if you are looking to create a long term retirement fund which is favourable in tax treatment and also promises attractive returns with balanced risk, NPS could be a great option for you. In case, you want to make additional tax-saving over and above Rs.1,50,000 under 80C, NPS is the right choice.
3. Public Provident Fund (PPF)
Lock-In: 15 years
Return: 7.1% (Q1 FY 2024-25)
PPF has remained one of the most popular tax saving instrument since long because of the government-backed guaranteed returns. However, in recent times it has shaded its seen due to the emergence of other attractive options of investment under section 80C including ELSS and NPS.
However, still, it is highly subscribed by the individuals looking for secured and guaranteed returns. Since the interest earned on PPF deposits is also exempted from income tax, it is much more preferred than Fixed deposits (FDs).
Currently, PPF deposits earn 8% interest rate compounded annually. The PPF rates are reviewed by the government every quarter.
The maturity period of PPF deposits is 15 years which makes PPF as a long term investment option. However, you can partially withdraw funds upto 50% of the deposits on certain prespecified grounds but only after completing 5 years.
Since the returns are government guaranteed, there is no issue of liquidity. It will get credited to your account on maturity.
If you are an absolutely risk-averse long-term investor and prefer to stay safe and secure with your investment, investing in PPF can be a great option for you. You can invest through a bank which provides you online access and investment in the account.
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4. Bank FDs
Lock-In: 5 Years
Returns: 6-7%
Subscribing for a tax saver fixed deposit can be another option to get the tax deduction facility under section 80C of the Income Tax Act, 1961. Though the tax saver FDs come with a minimum 5 years lock-in period but provide very moderate returns. Further, the interest income earned over the investment is fully taxable which means post-tax returns come down to just about 5.5% which does not look so attractive.
However, the subscription process for the tax saver FD is a matter of few minutes. You can invest in such product online using your net-banking and the proceeds get directly credited to your account on maturity. This can be a good option for making last-minute tax-saving decisions. Also, your capital does not get locked in for long term like in NPS and still you are better placed than low yielding ULIPs. Further, the provision of non-market linked assured returns provides an added layer of comfort to the conservative investors.
Banks offer different interest rates for regular depositors including individuals, senior citizens, NRIs and bank staff. The interest rates vary depending on different categories of applicants.
5. ULIPs
Lock-In: 5 Years (Minimum)
Return: 11-13% (Last 5 years)
Unit Linked Insurance Plans (ULIPs) are nothing but a combination of investment and insurance. When you make an investment in ULIP, essentially a part of your investment goes towards the premium payment of your insurance policy and the rest gets invested like a mutual fund. Since ULIPs are eligible for 80C deductions, it works like a 3 in 1 plan, where you can secure an insurance policy, earn market linked returns and save your income tax. Generally, ULIPs provide 10 times insurance coverage on the premium paid.
[ Also Read: 6 Best Tax Saving Investment Options ]
However, ULIPs are embedded with its own set of complexities which may compel you to rethink before making an investment in these products.
Firstly, there various kind of charges that you need to pay from the premium paid including mortality charges ( towards insurance), administrative expenses and fund management fees. In addition, a hefty sum is paid in the first year from your premium as agent commission. Rest of the investment only gets invested like mutual funds.
The information is not easily available that what part of your investment goes to insurance and what part to a fund. Therefore, you even can not do a cost-benefit analysis of your investment in ULIPs. All in all, ULIPs have a big issue on transparency and liquidity sides of your investment.
Then, the 5 year lock-in period of ULIPs is more theoretical than practical. As early termination of the policy may affect the returns negatively and take you out of the insurance coverage, generally it is a long term association.
Further, in case of the death of the ULIP investor, the nominee gets the sum assured or the fund value whichever is higher. You don’t get both separately. So if an investor buys a ULIP plan having an annual premium of Rs. 50,000 for 10 years with an insurance cover of Rs. 500,000 and dies in the 6th year of the policy, having a fund value of 425,000, he will just get Rs.500,000 as the insurance cover is higher than the fund value.
Ideally, it is best that the treats investments and insurance plans separately.
Also Read: A Comparison Between ELSS and ULIP