Tax Saving Products with Equity Edge
Written on Monday, February 22, 2016
By Sanjeev Puri
Making the right choice in life always helps. Similarly, making the right choice in selecting the right tax saving investment goes a long way in creating wealth for you. The Income Tax Act, 1961 provides for certain deductions that an individual may claim and thus reduce the taxable income thereby reducing tax liability. These benefits are largely confined to Section 80C of the Income Tax Act. According to Section 80 C, an amount equal to the investment that you make in certain specified instruments or an expense that you incur up to a maximum of Rs 1.5 lakh in a financial year reduces your taxable income by the same amount.
The deductions available under Section 80C include benefits for expenses incurred as well as for investments made. The investment related tax breaks are largely on specified investments, such as five-year notified tax saving bank deposits, life insurance premium, Employees’ Provident Fund (EPF), Public Provident Fund (PPF), National Savings Certificate (NSC), Senior Citizens’ Savings Scheme (SCSS) and Equity-linked Savings Scheme (ELSS) from mutual funds (MFs). Repayment of the principal on a home loan and payment of tuition fees also qualify for tax benefits under Section 80C.
Why fixed income tax savers do not create wealth?
The post-tax returns of the tax savers make them unfit for creating wealth over the long-term. Also, the inflation adjusted returns are low in them. For instance, most fixed and assured returns products such as National Savings Certificate (NSC) provides you with Section 80C benefits, but its returns, currently 8.8 (10-years) percent annually, is taxable. This makes its effective post tax return 6.08 per cent for highest tax payers. Of all the tax savers, only PPF, EPF, ELSS and insurance plans enjoy the EEE status i.e. the growth is tax-exempt during investing stage, growth stage and withdrawal stage. Considering, annual inflation of 6 percent, the real return is almost zero! Ignoring the impact of inflation is damaging to one’s wealth. Inflation erodes the purchasing power of money, especially over long-term.
Market-linked tax savers: The other is the ‘market-linked returns’ category, primarily being equity asset class. Here, one may choose from equity-linked savings schemes (ELSS) of mutual funds (MF) and the unit-linked insurance plan (ULIP) including pension plans and National Pension System(NPS). Further, there are three more MF schemes that are retirement focused and yet help you save tax- Reliance Retirement Fund, Franklin Templeton Retirement Fund and UTI Retirement Fund.
Equity Linked Savings Schemes (ELSS): As an investor in equity mutual funds, you should keep your investments in them aligned with your long-term goals. While doing so, if your investment can help you save taxes for you, nothing like it. There are specific mutual fund schemes called Equity-linked savings scheme (ELSS) which serve both the purposes. ELSS helps you save for long-term goals and also saves tax with only a 3 year lock-in period. ELSS investments enjoy tax benefits at all stages i.e. while investing, during the growth stage and also on redemption. Therefore, it has the EEE or the exempt-exempt-exempt status. The only tax saving investment option that provides tax-free returns for short periods is ELSS Mutual funds.
Unit linked insurance plans (ULIPs): Those who lack financial discipline and are unable to manage protection and savings separately, Ulips fit the bill. Ulip, because of its lock-in and longer horizon instills investing habit in investors. For protection of long term goals, sit with your insurer and ask them to generate an ‘Illustration benefit’ based on your age, term, sum assured and keeping an eye on various goals at different life stages. On a given sum assured, see how much premium needs to be paid, so that fund value at each life stage meets your requirement. The minimum sum assured has to be ten times of premium, but for someone using it for lifetime goals, keeping coverage of 15-20 times helps. As per the coverage amount, corresponding mortality charges keeps deducting from fund value.
Choose the Ulip that has a longer term to meet the goals at various life stages. Remember, under new guidelines, one has to continue paying the premiums till the end of the term i.e., till maturity. Earlier Ulips allowed premiums to be paid till three years or for a limited period of 5 years.
National Pension System (NPS): NPS has gained popularity in recent times. The credit goes to Budget 2015 announcement for bringing retirement to the forefront by giving it an additional tax benefit. NPS is a retirement focused scheme regulated by a statutory body, Pension Fund Regulatory and Development Authority (PFRDA). NPS is defined as contribution schemes i.e. what an investor accumulates and get as pension after retirement is dependent on how much is put into the scheme. The return therefore is not guaranteed but depends on the performance of underlying assets. What makes NPS stand out amongst several other investment alternatives is its low cost, easy accessibility and an option to build a corpus through market linked asset classes. Anyone between the age group of 18-60 can join NPS, with a minimum investment of Rs 6,000 a year after fulfilling the KYC requirements. One gets a Permanent Retirement Account Number (PRAN) which captures all the data including personal details and transactions. At age 60, the contribution stops and one is allowed to withdraw up to 60 percent of the corpus while annuity starts on the balance 40 percent of the NPS corpus from any of the seven designated annuity providers.