Smart ways to save tax
Choose the tax-saving
instrument that best suits your needs and financial goals.
Do-it-yourself tax planning
can be both rewarding and challenging. Reward ing, because you can choose the
tax-saving instrument that best suits your needs.Challenging, because if you
make the wrong choice, you are stuck with an unsuitable investment for at least
3-5 years, if not longer. This is where our annual ranking of best tax-saving
options can prove helpful. It assesses all the investment options on seven key
parameters--returns, safety, flexibility, liquidity, costs, transparency and
taxability of income. Each parameter is given equal weightage and a composite
score is worked out for the various tax-saving options.
While the ranking is based
on a robust methodology, your choice should also take into account your
requirements and financial goals. ELSS funds top the charts, but they may not
be the best option for a retired taxpayer. For him, the Senior Citizens' Saving
Scheme will be a better option even though it is ranked sixth and has been
assigned three stars. If he has already exhausted the `15 lakh investment limit
in the Senior Citizens' Saving Scheme, the next best option is the two-starred
NSCs and bank fixed deposits. For the grey population, especially those over
70, safety of capital is more important than beating inflation.
Similarly, though the NPS
offers additional tax deduction under the newly introduced Section 80CCD (1b),
taxpayers must keep in mind the liquidity and taxability of the corpus. You
can't take out the money before 60 years of age and at least 40% of the
maturity amount has to be put in an annuity to get a monthly pension. To make
matters worse, this pension is fully taxable as income. Experts believe that
annuity income should be tax-free to make retirement planning more popular. The
Pension Fund Regulatory and Development Authority (PFRDA) has reportedly sought
tax exemption for annuity income, but it is not clear whether the Finance
Ministry will oblige in this year's Budget.
In the following pages, we
shall consider the pros and cons of each option and tell you which instrument
is best suited for taxpayers in different situations and lifestages. We hope it
will help you make an informed choice.Happy investing!
ELSS FUNDS
If ELSS funds top our
ranking for the second consecutive year, it is be cause of their tremendous
potential, high liquidity and greater transparency. The ELSS category has given
average returns of 17.8% in the past three years. The three-year lock-in period
is the shortest for any Section 80C option.What's more, you can get some of the
investment back if you opt for the dividend option. It is also very easy to get
details of the fund's portfolio. Add to these advantages the ease of investment
that mutual fund houses are offering. If you have already fulfilled the KYC
requirements, you can invest online.Even if you are a new investor, fund houses
facilitate the investment by picking up the documents from your house and
guiding you through the KYC screening.
ELSS funds are equity
schemes and carry the same market risk as any other diversified fund. The
previous year was not good for equities, with the Sensex ending the year with a
5% loss. Even some top-rated ELSS funds lost money in the past year. Investors
who opted for the ultra-safe PPF would have made more money (see table). However,
the picture changes when you look at the long-term performance. ELSS funds are
miles ahead of the PPF in the 3-year and 5-year returns.
The SIP route is the best
way to contain the risk of investing in equity funds.However, with just three
months left for the financial year to end, this window is almost closed now. At
best, a taxpayer will manage 2-3 SIP instalments before 31 March. At the same
time, valuations are not very stretched right now, so one can consider putting
a bigger amount.
ULIP
There are many reasons why
Ulips are at second place in our ranking. The new on line Ulips are ultra
cheap, with some of them costing even less than direct mutual funds.They also
offer greater flexibility. Unlike ELSS funds, where the investment cannot be
touched before three years, Ulip investors can switch their corpus from equity
to debt, and vice versa.What's more, there is no tax implication of the gains
made from such switching because insurance plans enjoy exemption under Section
10 (10d). Even so, only savvy investors who know how to utilise the switching
facility should get in.“There is no need to switch if you are not an expert in
market timing,“ says Bhuvana Shreeram, head of Financial Freedom Golden
Practices.
NPS
Last year's budget made the
NPS more attractive as a tax-saving tool by offer ing an additional tax
deduction of `50,000. Also, pension fund managers have been allowed to invest
in a larger basket of stocks and no longer have to invest passively by
mirroring the index. Active investments in stocks will help generate better
returns for investors. Even so, concerns remain about the cap on equity
exposure. For a young investor, the 50% ceiling may be too conservative an
allocation. Besides, the taxability of the NPS on maturity is a sore point. At
least 40% of the corpus must be put in an annuity. Right now, the income from
annuities is taxed at the normal rate, though the government is considering tax
exemption for annuity income.
PPF AND VPF
Though the ultra-safe PPF
has slipped to fourth place in the ranking this year, it still remains a good
option for the conservative investor who doesn't mind earning less as long as
the returns are assured. It's been almost four years since the PPF rate was
linked to the benchmark bond yield. But bond yields have stayed buoyant in the
past four years so the PPF rate has not fallen. However, the government has
indicated that it will review the interest rates on small savings schemes,
including the PPF and NSCs.
If this is a worry, opt for
the Voluntary Provident Fund. It offers that same interest rate and tax
benefits as the Employees' Provident Fund. Given the political implications of
reducing the interest rate on the EPF, it is unlikely that the VPF rate will
see a cut in the near future. What's more, there is no limit to how much you
can invest in the VPF. The best part is that the contribution gets deducted
from the salary itself so the investor does not even feel it go.
SUKANYA SAMRIDDHI SCHEME
A new entrant in the
ranking, this scheme for the girl child is a great way to save tax. However,
given its limited scope, it does not figure very high in the ranking. It is
open only to girls below 10. If you have a daughter that old, the Sukanya
Samriddhi Scheme is a better option than the bank deposits, child plans and even
the PPF account you opened for her education and marriage.
Accounts can be opened in
any post office or designated branches of PSU banks with a minimum investment
of `1,000. The maximum investment in a financial year is `1.5 lakh and deposits
can be made for 14 years after opening the account. A parent can open an
account for a maximum of two daughters, but the combined investment in the two
accounts cannot exceed `1.5 lakh a year. The account matures when the girl
turns 21, though up to 50% of the corpus can be withdrawn after she is 18 or
gets married.
SENIOR CITIZENS' SAVING SCHEME
As mentioned earlier, this
is the best tax-saving instrument for retirees.
At 9.3%, it also offers the
highest interest rate among all Post Office schemes. The tenure of the scheme
is five years, which is extendable by another three years. The interest is paid
out in quarterly tranches on fixed dates, irrespective of when you invested.
However, there is a `15 lakh overall investment limit per individual.
Also, the scheme is open
only to investors above 60. In some cases, where the investor has opted for
voluntary retirement and has not taken up another job, the minimum age is
relaxed to 58 years. There is also no age bar for defence personnel. They can
invest in the scheme even before 60 as long as they satisfy the other
requirements.
Though bank fixed deposits
and NSCs are ultra-safe and offer assured re turns, there is a heavy price to
be paid for this safety and surety of returns. The interest earned on the
deposits is fully taxable, so the post-tax returns are not very lucrative (see
table). Those in the highest 30% tax bracket (taxable income of over `10 lakh a
year) should not invest in these deposits.They are best suited to taxpayers in
the 10% bracket (taxable income of less than `5 lakh a year) or senior citizens
who have already exhausted the `15 lakh overall investment limit in the Senior
Citizens' Saving Scheme.
Don't let the high interest
rates offered on the 5-year and 10-year NSCs mislead you.Since the interest is
fully taxable, the post-tax yield is far lower. In the 30% tax bracket, it is
close to 6% (see table). The tax-free PPF is a far better option than these
instruments.
The positive feature of
bank deposits and NSCs is that they are straightforward instruments and don't
require a multi-year commitment. If you don't have time to study the fine print
of other options and the deadline is nearing, invest in fixed deposits.
They are also widely
available. Just walk into any bank branch or Post Office branch and invest. Of
course, you will have to comply with the KYC norms while doing so.
One ticklish area is the
TDS rule. If the interest income exceeds `10,000 in a year, the bank will
deduct TDS. Some investors try to avoid the TDS by splitting their investments
across 2-3 banks. This is not a good idea because one has to pay tax on this
income. In fact, the TDS is only 10% on the interest earned. If the taxpayer is
in the higher income slab, he will have to pay more tax.
On the other hand, some retired
taxpayers are subjected to TDS even though they are not liable to tax. Since
their total income from interest exceeds the threshold, they have to first pay
tax and then claim it back after they file returns. This problem needs to be
fixed.
PENSION PLANS
Pension plans from
insurance companies do not enjoy the same tax benefits as the NPS.
The additional deduction of
`50,000 under Sec 80CCD(1b) is reserved exclusively for the government-promoted
pension scheme. But pension fund managers dismiss the charge that this is an
unfair advantage. “The retirement funds from mutual funds are not really
pension products. And the cost structure of pension plans from insurance
companies is not very favourable to buyers. The NPS is the only true low-cost
pension product,“ says Balram Bhagat, CEO and Wholetime Director, UTI
Retirement Solutions.
To be sure, pension plans
still have very high charges which makes them poor investments.They also force
the investor to put a larger portion (66%) of the corpus in an annuity. The
prevailing annuity rates are not very attractive. For instance, if a a
60-year-old man invests `10 lakh, LIC will give him `7,792 per month for life.
The pension plans launched
by mutual funds have lower charges, but these are actually mutual funds
disguised as pension plans. Moreover, they are debt-oriented plans so they are
not eligible for the tax benefits that equity plans enjoy. ELSS funds will be
better alternatives to these plans.
INSURANCE POLICIES
For the third consecutive
year, traditional life insurance policies remain the worst way to save tax.
Still, mil lions of taxpayers buy these policies every year, lured by the
“triple benefits“ of life insurance cover, long-term savings and tax benefits.
Actually, these policies give very little cover. A premium of `20,000 a year
will get you a cover of roughly `2 lakh. The returns are very poor, barely 6%
if you opt for a 20-year plan. And the tax-free income is a sham. Go ing by the
indexation rule, if the returns are below the inflation rate, the income should
anyway be tax free.
The bigger problem is that
once you sign up for these policies, they become millstones around your neck.
Dhiraj Das (see picture) understands this only too well. He is paying roughly
`5 lakh a year for a clutch of traditional insurance policies. “Buying these
low-yield policies was a big mistake.If I stop paying the premium, they will
lapse and I will lose the premiums paid till now,“ he says. We suggest he
should turn these plans into paid-up policies after three years.
Insurance should not be
mixed with investment. Rakshita Dwivedi (see picture) has stayed away from such
plans. The only insurance policy she has is a pure protection term plan.
ETW4JAN16
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