It’s that time of the year again when you dread the call from the accounts department. Here comes Mr Plusandminus, you mutter under your breath as you hit open on the mail with his name. The usual threat—if you don’t tell me what your 80C is, I will give you no salary—pops up. The rush to placate Mr Plusandminus and keep the salary cheque intact, you look for the nearest product to hit your money with. Don’t do that this year? Our constant advice stays the same: don’t just save tax, make long-term investments.
Read all week this special package that tells you what to do and what to absolutely not do. We begin by listing and describing the three products that are likely to escape the direct taxes code (DTC) axe next year and continue to enjoy the tax advantage. They lend a long-term character to your investment portfolio and are absolute must-haves for Mint Money readers.
Employees’ Provident Fund
If you are a salaried individual, then this is probably the best investment product you have in your portfolio. Every month you park 12% of your basic plus dearness allowance in your account and your employer matches the investment. From what your employer contributes, 8.33% goes into the Employees’ Pension Scheme, or EPS, which offers you pension for life after the age of 58 years. The remaining corpus then earns a rate, which is declared by the Employees Provident Fund Organisation (EPFO) for each fiscal year.
EPF gives you a tax-free and risk-free return of 8.5% per annum. This year the rate became more attractive when the central board of trustees of the EPFO declared a rate of 9.5% for FY11. However, the increase of a percentage point has been rejected by the ministry of finance. Whether your EPF kitty will get extra is a story that’s still unfolding. However, even the 8.5% that EPF has been declaring over the past four years is unbeatable in the debt space.
Tax treatment: The contributions you make in your EPF, the interest your kitty earns and the money that you get are all tax-exempt. In other words, it is proposed that EPF will get the exempt-exempt-exempt, or EEE, treatment. Your contributions qualify for a tax deduction of up to Rs1 lakh under section 80C.
DTC proposes that EPF will continue to remain unmatched as it makes it to the list of long-term products that will continue to enjoy EEE treatment.
Who should invest: Before you turn to other tax-saving instruments, you should first factor in the contributions you make to your EPF. If your annual basic salary crosses Rs8.3 lakh, your contributions to EPF crosses Rs1 lakh, which is the limit under section 80C. This tax season, factor in your EPF contributions and then plug the shortfall.
Public Provident Fund
The next gem in the section 80C basket is Public Provident Fund (PPF). It is a zero-risk, zero-cost product that compounds your kitty by 8% every year. Considering long-term inflation averages to about 6%, an 8% return gives your portfolio a push and since you get this without any risk you must consider exhausting this investment option.
You need to invest in your PPF account every year. You need to put at least Rs500 up to a maximum of Rs70,000. PPF is available for 15 years and can be extended by blocks of five years. Assuming you exhaust your limit of Rs70,000 every year, an 8% return on your investment would mean you will have a corpus of about Rs19 lakh after 15 years. And this is without any risk or cost; however, the PPF rate can be changed by the government of India.
Tax treatment: Just like EPF, PPF also comes under the EEE regime. Your contributions qualify for a tax deduction under section 80C and the interest and the maturity corpus are tax-exempt. Even under the proposed DTC, PPF is likely to retain its tax advantage.
Who should invest: Salaried individuals can plug the shortfall in the 80C limit by investing in PPF. For non-salaried individuals, this is an excellent investment vehicle. Even as PPF lets you make partial withdrawals after five years, it is best to keep it going for the long term. PPF works best to service a long-term goal that can range from purchasing a house to your kid’s education or marriage. And since it can be extended, it is a good vehicle to save for your silver years.
Says Harbinder Mehra, founder, Pensionindia.com, an education portal on retirement planning: “Long-term vehicles such as PPF and EPF will continue to enjoy tax advantage and given the rate of return and the fact that they are risk-free make them vital investment products. We advise investors to first exhaust these options to lend stability to the portfolio before they dabble in other products such as equity-linked savings scheme.”
New Pension System
A fairly new arrival in the basket of 80C products, which is still struggling for attention, New Pension System (NPS) has the most cost-efficient structure in the genre of managed funds. And with a watertight architecture, NPS is among our favourite investment vehicles for retirement.
The tier I account, known as the pension account, invests in the funds of your choice and locks in your money till 60 years of age. There are three funds to choose from: equity fund in which you can invest up to 50% in index funds, fixed income instruments other than government securities, and government securities. At 60, you get back the lump sum, but you need to buy an annuity or a pension product with at least 40% of the corpus.
With a fund management charge of 0.0009% per annum, it is the cheapest managed fund so far, but is still struggling to find its feet. Pension funds regulator, Pension Fund Regulatory and Development Authority is looking to revamp the model by hiking fund management charge and introducing higher incentives to distributors. However, the regulator claims that even if the fund management charge is increased, NPS will continue to dominate the space of cheapest investment option.
Tax treatment: There is no limit to the contribution you make under NPS, but only 10% of your income is applicable for tax deduction under section 80CCD. However, the deduction is available subject to a maximum of Rs1 lakh under section 80C. On maturity, the 60% that you get as lump sum is taxable. The remaining 40% that goes into buying annuity is exempt, but the pension money you would get would be taxable as income in your hands.
However, when DTC is implemented, NPS is likely to be on a par with other long-term vehicles as the new tax law proposes to bring it under the EEE regime. Which means you can claim a deduction of up to Rs1 lakh and the corpus that you get on maturity is tax-exempt.
Who should invest: If you belong to the unorganized sector or are self-employed without any EPF benefits, you must consider NPS. Even for those who are risk averse, NPS works as a good retirement tool.
In fact, now you can also invest in NPS online. FundsIndia.com, an online investment portal, and ICICIdirect.com, the online broking site of ICICI Securities Ltd, enable you to do so. Says Pankaj Mathpal, founder, Pankaj Mathpal and Associates, a Mumbai-based financial planning firm: “NPS is a good product for those who have a moderate risk profile and have little knowledge about equity markets. Young investors should opt for equity funds up to the maximum limit of 50% since the investment horizon is long term.”
Watch this space to know more about the next hot favourite in the basket of section 80C—life insurance policy. What should be your strategy when buying life insurance and how to DTC-proof it.