Tax-saving options and investments for the risk-averse

There are a variety of tax-saving options like ELSS (equity-linked savings scheme) and ULIPs (unit-linked insurance plan) that give you tax benefits along with wealth creation under Section 80C of the Income Tax Act.

Mar 04, 2019 03:03 IST India Infoline News Service

tax-saving
There are a variety of tax-saving options like ELSS (equity-linked savings scheme) and ULIPs (unit-linked insurance plan) that give you tax benefits along with wealth creation under Section 80C of the Income Tax Act. However, these products have an equity component, and thus, market risk becomes integral to these products. What if someone is entirely risk-averse and wants tax-saving with safety. Broadly, for such individuals, there are three categories to choose from:
  • Safe investments that are tax-free
  • Safe investments that are tax-exempt
  • Safe investments that are tax-free and tax-exempt
  • But how exactly do they help save tax for a risk-averse person? Let us take a look.
 
Safe investments that are tax-free
The Government of India has authorized certain infrastructure facilitators like the IRFC, HUDCO, and NHAI to issue tax-free bonds. Such bonds have very long maturities of 10-15 years and are best suited to investors in higher income brackets. The interest earned on these bonds is entirely tax-free in the hands of the investor. Currently, such tax-free bonds pay an interest rate of around 7% but since the interest is tax-free, the effective pre-tax yield works out to be much higher. For example, a 7% bond in the 30% tax bracket will have an effective pre-tax yield of 10% {(7/(1-0.30)}. Here, only the interest earned on these bonds is tax-free and there are no additional benefits.
 
Safe investments that are tax-exempt
In the above-mentioned investment, only the interest income earned is tax-free. In the case of tax-exempt investments, the exemption benefit is on the principal investment itself. Section 80C of the Income Tax Act is a classic example of tax exemption where the amount invested gets deducted from taxable income. So what are the safe tax-exempt options?
 
Long-term bank deposits and long-term post office deposits fall under this category. In both these cases, the investment entitles the investor to an exemption up to Rs1.50 lakh per year. This is an overall umbrella limit and includes a host of other instruments and outlays too. In the case of tax-exempt instruments like long-term deposits, the interest income is taxable at the peak rate and it is only the investment amount that entitles you to tax exemption under Section 80C.
 
Safe investments that are tax-free and tax-exempt
Are there investments that are tax-free and also provide tax exemption? Yes, but only one - the public provident fund (PPF). You can open a PPF account with any bank or post office and it requires minimum documentation. As it is government-backed, it is also free of default risk. The interest rate is normally reset each year and the current rate of applicable interest is 8%. Interest is accumulated and paid at the time of withdrawal/maturity and is entirely tax-free in the hands of the investor. In addition, investment in PPF also entitles you to tax exemption under Section 80C of the Income Tax Act.
 
If you are looking at smart tax-saving investments that are absolutely safe, take your pick from the above. Of course, we can argue that the biggest risk over the long-term is not taking on any risk. But we can leave that for another discussion!

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