In my last post I discussed how tax is calculated from salary. In this one, I’ll discuss some of the various tax saving instruments that are currently available. If your income exceeds 2.5 lakh per annum then you are liable to pay tax. Thus, it is imperative to save your income from getting taxed.
You should start tax planning from the beginning of the fiscal year itself, in order to avoid last minute rush which often leads to bad investment decisions. In order to do that, you should be aware of the various tax saving investments which not only allows reduction of tax liability, but also the scope for capital appreciation.
The investments can be broadly classified as:
Income earned from the investments are not taxable. For e.g. PPF, tax free bonds and etc.
Tax Rebate or Tax Saving: Investment amount for these investments can be subtracted from the taxable income bringing down the overall tax liability. For e.g. EPF, ELSS Funds and etc.
Tax Arbitrage Investments: Provide tax benefit when compared to other instruments. For e.g. FMPs
Tax Free Investments:
PPF (Public Provident Fund):
This takes the crown when it comes to tax-free assured returns. It provides you the ability to reduce your tax liability as you can deduct the sum invested from the taxable income. The returns are completely tax-free!! Even though, the interest rate has been reduced to 7.9% (revisable every quarter) compounded annually, PPF is one good investment. The minimum amount that can be invested annually is Rs.500 and since it falls under 80C, the maximum investment can be of Rs.1,50,000. The amount invested gets locked-in for a period of 15 years. However, partial withdrawal can be done from end of sixth year onwards.
Tax Free bonds:
For people in higher tax bracket and having a low-risk appetite, tax free bonds are a good investment option. The bonds are issued by companies backed by government and hence the risks are low. However, with low risk comes decent returns considering the post tax yield has been around 7% per annum. The interest received from these bonds is tax-free. Tax free bonds are listed in the Stock Exchange. However, you can also buy them directly from the issuer which entails a slight benefit of higher interest rate than being offered on the stock market. Do note that, the bonds must be held till maturity in order to get the return tax-free.
Maturity proceeds of Life Insurance Policies:
As long as the sum assured is ten times or more than the premium, the proceeds are tax free. However, it should be noted that, if the main concern is life insurance, then it is always better to go for term policies.
Tax Saving Investments:
Major tax saving investments are as follows:
ELSS or Equity Linked Savings Scheme mutual funds are funds which invest in shares (hence, market-linked returns), and provide Income Tax rebate. The minimum amount that can be invested is Rs.500 per annum. There is no limit on maximum amount that can be invested. Since this instrument falls under 80C, the maximum amount eligible for deduction under 80C is Rs.1,50,000. The lock-in period of ELSS is 3 years and the Dividends and capital gains are tax free. Note that ELSS do not offer premature withdrawal.
National Savings Certificate:
5 yr NSCs offer an interest rate of 8.8%. It’s a safe investment and can be held jointly. There is no upper limit on the amount that is being invested with the lower limit being Rs.100. Nomination facility is provided when investing in NSCs. The certificates can only be encashed at the post office where they were issued however, if the holder can provide sufficient evidence that he is entitled to the proceeds then they can be encashed as any post office. The certificates can also be taken on behalf of a minor. The interest can be virtually tax free except for the interest that is earned in the last year. Do note that the tenure is 6 years. The maximum investment amount eligible for deduction is Rs.1.5 lakhs.
Employee Provident Fund (EPF):
EPF has two elements – i) Provident Fund and ii) EPS (Employee Pension Scheme). The subscriber has to contribute 12% of his Basic+DA towards EPF which in its entirety goes into Provident Fund. Out of the employer’s contribution of 12%, 8.33% goes towards EPS (subject to max. Rs.541) and the rest goes to Provident Fund. EPF currently provides an interest rate of 8.65%. One can withdraw the amount in case of job change, however it’ll be subjected to tax. Full withdrawal is permitted in case of being unemployed for more than 60 days.
Tax Saving Fixed Deposits:
These are like regular fixed deposits having a lock-in period of 5 years. As they come under 80C, the maximum amount eligible for deduction is 1.5 lakhs. The interest earned is taxable and tax is deducted at source. Premature withdrawal is not available. The minimum amount that can be invested is Rs.100.
Life Insurance Covered under 80C:
Life insurance schemes (ULIPs and Non-ULIPS) are covered under 80C and can be invested in to get a tax benefit up to the limit of Rs.1.5 lakh within 80C. The limit is applicable on the combined investment under 80C and not just insurance premiums. To be eligible for deduction u/s 80C, the amount paid by you should be towards life insurance premium for yourself, your spouse or your children. Life insurance premium paid by you for your parents (father/mother/both) or your in-laws is NOT eligible for deduction under this section.
The New Pension Scheme is very cost-effective as the fund management charges are low. It’s voluntary and any citizen of India in the age range of 18-60 years is eligible for participation. The invested amount is managed in three separate accounts having distinct asset profiles: Equity, Corporate Bonds and Government Securities. You can manage your portfolio actively or passively (auto-choice). Contributions made to the NPS are covered under Section 80CCD of the Income Tax Act. NPS provides a maximum deduction of Rs.50,000. This is suitable for individuals who have varying risk appetites and are looking to set aside money for retirement. The negative point is that at least 40% of the corpus must be put in an annuity. The income from annuities is taxed at the normal rate.
Tax Arbitrage Investments:
Fixed Maturity Plans:
FMPs are close ended debt schemes with a fixed maturity date. The money is invested in debt and money market instruments maturing on or before the date of maturity of the scheme. Returns are taxed at long term capital gains rate. Thus, this option is beneficial for those who fall in the 30% tax bracket.
All the above instruments are good for saving tax. Now it’s up to you to choose your options and invest in order to save tax as well as gain maximum returns in the process. This is where prudent tax planning comes into picture. There are certain factors that one should consider during tax planning. I’ll discuss those factors in my next post. So, stay tuned…