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The tax-saving season is on and both the salaried and non-salaried taxpayers would have started comparing tax saving investment options for the financial year 2019-20.
As an investor, one should look for investment options that not only help you save tax but also generate tax-free income.
In tax-saving financial products like the National Savings Certificate (NSC), Senior Citizens’ Savings Scheme (SCSS), 5-year time deposits with banks and post offices, the interest amount gets added to your income and therefore is liable to be entirely taxed.
The post-tax return in a taxable instrument comes down after factoring in tax. For someone who pays 30 per cent tax, the post-tax return on a 5-year bank fixed deposit of 7 per cent is 4.9 per cent per annum, excluding the surcharge!
1. EQUITY-LINKED SAVINGS SCHEMES
From April 1, 2018, any LTCG made on transfer of equity MFs that have an equity exposure of 65 per cent or more including Equity-linked savings schemes (ELSS) will have to pay a 10 per cent tax on long-term gains. It is important to note that gains made above Rs 1 lakh per annum will only be subject to tax and any gains made below that limit in one FY remains tax-exempt. The LTCG made till January 31, 2018, however, remains grandfathered i.e., those gains remains tax-exempt.
Equity-linked savings schemes (ELSS) are diversified equity mutual funds with two differentiating features – one, investment amount in them qualifies for tax benefit under Section 80C of the Income Tax Act, 1961, up to a limit of Rs 1.5 lakh a year and secondly, the amount invested has a lock-in period of 3 years. Every mutual fund (MF) house offers them and generally uses the word tax-saving in its name to distinguish them from their other mutual fund schemes.
2. PUBLIC PROVIDENT FUND
For decades, the Public Provident Fund (PPF) Scheme has been a favourite savings avenue for several investors and is still standing tall. After all, the principal and the interest earned have a sovereign guarantee and the returns are tax-free.
PPF currently (subject to change every three months) offers 7.9% per cent per annum. For someone paying 31.2 per cent tax (highest income slab), it translates to nearly 11.48 per cent taxable return. Now, how many taxable investments including bank FD’s are providing such high pre-tax return!
Whom it suits: PPF suits those investors who do not want volatility in returns akin to the equity asset class. However, for long-term goals and especially when the inflation-adjusted target amount is high, it is better to take equity exposure, preferably through equity mutual funds, including ELSS tax saving funds and not solely depend on PPF.
3. EMPLOYEES’ PROVIDENT FUND
Employees’ Provident Fund (EPF) is another avenue that helps a salaried individual not only helps save tax through involuntary savings but also accumulate tax-free corpus. An employee contributes 12 percent of one’s basic salary each month mandatorily towards his EPF account. An equal share is contributed by the employer but only a portion (3.67 per cent) goes into EPF.
Although one may opt-out from VPF by intimating one’s employer, the money contributed towards VPF, which represents additional savings towards retirement, get locked-in for a longer tenure, and hence use the VPF route judiciously.
4.UNIT LINKED INSURANCE PLAN
Unit linked insurance plan (Ulip) is a hybrid product, a combo of protection and saving. It not only provides life insurance but also helps channel one’s savings into various market-linked assets for meeting long-term goals.
In most Ulips, there are 5 to 9 fund options with varying asset allocation between equity and debt. A Ulip can have a duration of 15 or 20 years or more but the lock-in period is 5 years. The fund value on exiting the policy (allowed after 5 years) or on maturity is tax-free. Any switching between the fund’s options irrespective of the holding period is exempt from tax.
Whom does Ulips suit: Ulips may not be suitable for all investors. Those investors who are comfortable in identifying and managing the ELSS schemes and simultaneously hold a pure term insurance plan, need not buy Ulips. Also, investors looking at investing in Ulips should make sure that the fund value on exiting the policy (allowed after 5 years) or on maturity is tax-free. Any switching between the fund’s options irrespective of the holding period is exempt from tax.
5. Traditional insurance plans
Traditional insurance plans could be an endowment, money-back or a whole life plan. Unlike pure term insurance plans they have a savings element in them and come with a fixed term and a fixed sum assured. The premiums are based on the age at the time of entry, the life coverage and the period for which coverage is required.
Where traditional plans fail: Traditional plans are inflexible in nature. The term once chosen can’t be changed. For someone who has started saving for say, 20 years might need funds in the 16th or 19th year. Most such plans also do not allow partial withdrawals. Even sum assured can’t be changed. The traditional insurance plans including endowment, money back or of any design have a potential for lower returns and are largely in the range of 4-7 per cent per annum.
6. SUKANYA SAMRIDDHI YOJANA
Sukanya Samriddhi Yojana (SSY) is a small deposit scheme for the girl child launched as a part of the ‘Beti Bachao Beti Padhao’ campaign. It is currently fetching an interest rate of 8.4 per cent and provides income-tax benefit.
A Sukanya Samriddhi Account can be opened any time after the birth of a girl till she turns 10, with a minimum deposit of Rs 250 (Earlier Rs 1,000). A maximum of Rs 1.5 lakh can be deposited during the ongoing financial year. The account will remain operative for 21 years from the date of its opening or until the marriage of the girl after she turns 18.
Currently, SSY offers the highest tax-free return (8.4 per cent per annum) with a sovereign guarantee and comes with the exempt-exempt-exempt (EEE) status. The annual deposit (contributions) qualifies for Section 80C benefit and the maturity benefits are non-taxable.