The end of the third quarter of the financial year should be the alarm to plan tax saving under Sections 80C to 80GGC. The Income Tax Act specifies deductions from gross total income under these sections. Section 80C is the most important section for an individual or an HUF (Hindu Undivided Family) which provides deduction up to Rs. 1 lakh through certain instruments. Apart from a few tax free expenses, these instruments largely comprise tax saving investments, which range from pure debt to pure equity options. Therefore, one needs to explore each option in the context of one’s personal financial situation.
Role of tax saving instruments
Most of the tax saving instruments are great financial products and effectively participate in various financial needs of one’s life. Please refer table 1.
Note: Maximum deduction available under Sections 80C, 80CCC & 80CCD can’t exceed Rs. 1 lakh. #Partial withdrawals are subject to certain conditions.
Some other expenses are also available for deductions under Section 80DD to 80U which will work for very specific cases and are not common in nature.
Tax planning step by step process
A handpicked combination of tax saving instruments not only reduces tax liability of the individual but also effectively contributes to meet various life goals.
Ensuring secure financial future for dependants are one of the most important needs of one’s life. To meet this essential expenditure, Section 80C & 80D allow deduction to taxpayers for the premium of life and medical insurance policies respectively.
Since life insurance is a long term contract, one may incur some losses in case of exit the policy mid-way. There are many similar options available with insurance companies. So the insurance cover must be from carefully selected right product mix. Term plans should always be the first choice, also from the viewpoint of taxation. Since premium of term plan used to be low, it gives enough scope to claim deduction on other investments allowed under 80C within the limit of Rs. 1 lakh.
The possibility of one undergoing some kind of expensive health treatment during the lifetime is much more than a sudden demise. The rising healthcare costs have made people understand the importance of having a health care policy, especially in case of parents. As an individual get older, the medical expenses may increase but the chances of getting a good cover decreases. The wide range of healthcare policies makes it important to select a good plan for a healthy future.
A retirement plan aims to build a sufficient corpus for a happy and restful retired life. The need of regular income prioritises the place of debt in such portfolio. Some of the tax saving investments such as PPF (Public Provident Fund) and SCSS (Senior Citizen Savings Scheme) are great debt oriented retirement products.
The excellent one of them is provident fund which is ideal for long term investment. With a tax free return of 8.8%, PPF is a tax saving option wrapped in safety with an attractive yield. For an investor in the tax bracket of 30.09%, the pre-tax yield comes of 12.587% with exemption of wealth tax and the protection from attachment by any order or decree of court. As the interest on PPF is tax exempt, there’s no income to be clubbed under the clubbing provisions if invested in the name of spouse or minor child. The accumulated balance of EPF is also tax free if the employee continuously works with a firm for five years or transfer account with the change of job.
The SCSS is a government of India deposit scheme for citizens of 60 years of age or above. Employees who have retired on superannuation or under a voluntary retirement scheme can invest even in the age of 55 years. The scheme is available at post offices and designated banks.
The next product from the Section 80C is pension and annuity plans which aim to provide regular income during retirement. But these plans don’t appear an attractive option because of their complex expense structure and comparatively low return. At maturity, one-third of the amount from the pension fund is tax-free and the rest is used to buy annuity plans. It implies that one has to buy an immediate annuity, even when other kinds of investment might offer greater returns.
Without doubt, if one has to select a tax saving product from the viewpoint of retirement planning, it should be the time tested provident fund. SCSS can be added in the portfolio when the investor reaches the age of 60.
After exploring above mentioned options and taking account of the eligible expenses, if any balance figure is due to invest to touch the limit of Rs. 1 lakh, a match should be established between clients’ objective and tenure of the investment product while keeping an eye on after tax return. ELSS or tax saving mutual fund scheme is the most effective and attractive investment product among available options. It provides the best hedge against inflation. After a lock-in period of three years, investors are free to hold or withdraw this investment. Tax saving funds are diversified equity schemes which are usually large cap oriented. These funds carry some risk but also offer better return than other products. Young investors should take a long term view and seriously consider investing in ELSS.
A new tax saving scheme called Rajiv Gandhi Equity Saving Scheme (RGESS) is introduced this financial year. It is exclusively for the first time retail investors in securities Market whose annual income is below Rs. 10 lakh. Even if one has demat account, but has never transacted in equity or derivative, he is eligible for this scheme. The maximum investment permissible for tax deduction under the scheme is Rs. 50,000 and the investor would get a 50% deduction of the amount invested.
Following securities are eligible under this scheme:
Although the lock-in period is of three years from the date of last purchase of securities, investors would be allowed to trade after the first year with certain restrictions. RGESS may prove a good option for new retail investors to have a flavour of direct equity.
Investments to save taxes are one of the commonest and yet one of the least well planned investments. At the start of the career an individual usually starts his saving with tax saving instruments but without any plan. Once he starts to take his financial decisions randomly, it takes a long to come him back on right track. The duality of concerns, first tax and second investment, prevents investors to perfectly understand what they actually need. One must realise that tax saving instruments do much more than only saving taxes. Smart planning with right tax saving instruments adds value to a portfolio. So take a wiser approach and avoid last minute rush for tax saving.
The writer is certified financial planner, Financial Planning & Knowledge Centre
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