There's more to tax-saving products

This year you can save some more tax. The Union budget last year increased the tax deduction limit under section 80C from 1 lakh to 1.5 lakh. This means you get to save 5,150 more on taxes if you are in the 10.3% tax bracket, and 15,450 if you are in the highest tax bracket of 30.9%. While a hike in deduction is good news because not only do you save more tax but are also incentivized to make investments in the section 80C basket, the confusing part is how to go about saving that tax. This confusion is directly proportional to the amount you delay in making your investments.

Last minute panic will mostly steer you towards unwise decisions like buying insurance policies regardless of your needs, which is why Mint strongly recommends that you avoid bunching your investment decisions for the end of the year. Instead, it is better to spread it through the year, preferably towards the beginning of the year. However, if you are already late, then make sure you heed our advice in the next financial year. For the time being, we open up the 80C basket to help you pick wisely.

Products galore

In terms of investments, the 80C basket consists of these vehicles: Public Provident Fund (PPF), Employees’ Provident Fund (EPF), equity-linked savings scheme (ELSS), premiums paid towards life insurance, National Savings Certificate (NSC), Senior Citizens Savings Scheme (SCSS), and five-year term deposits in banks and post office.

PPF, EPF, ELSS and life insurance policies all enjoy exempt-exempt-exempt tax status. This means that the initial contribution, interest earned or maturity proceeds are all tax-free. For NSC, the initial contributions and interest that accrues every year and gets reinvested qualify for 80C deduction. But the interest income is taxable on accrual basis. In case of SCSS and term deposits, the interest income is also taxable.

Other than these, pension plans under section 80CCC, pension plans by life insurance companies, and the National Pension System (NPS) under 80CCD also qualify for a tax deduction within the overall limit of section 80C. But the deduction limit on these vehicles has been retained at 1 lakh. In other words, contributions towards pension plans offered by life insurance companies and the NPS will qualify for a deduction of only up to 1 lakh. “Tax deduction limit on pension plans by insurers and NPS is retained at 1 lakh. However, they are subject to the overall cap under section 80CCE of 1.50 lakh. So, while as individual products (for NPS and pension plans of life insurers) the tax deduction limit is 1 lakh each under respective sections 80CCC and 80 CCD of the Income-tax Act but collectively these qualify for tax deduction of up to 1.5 lakh,” said Sonu Iyer, partner and national leader, human capital services, EY.

After you have understood the tax treatment of these products, the next step is to understand which products to pick.

Big picture

Before you make a choice, you need to go back to the basics of personal finance; focus on your goals and asset allocation, but first check whether you are adequately insured.

Start with reviewing your insurance cover. Ideally, your insurance cover should be 8-10 times your annual income. Pick up the plain vanilla term plan that only gives insurance. If you buy it online you can get a further discount on the premium. In fact, insurers have started designing term plans that offer periodic income along with a lump sum to the beneficiary on the policyholder’s death during the policy term. Periodic income comes in handy for those who may not know how to utilize a lump sum right away.

After insurance comes investments, and for that you need to be mindful of three things: goals, time horizons and your risk appetite. “Tax saving is important, but investments for tax saving should overall mesh with the savings requirements. They should match the tenor, your liquidity needs and should fulfil risk and return expectations. It has to be chosen keeping all these in consideration,” said Suresh Sadagopan, certified financial planner, Ladder 7 Financial Advisory, a financial planning firm.

While section 80C products give you options to save for medium-term goals, for instance the 5-year tax saving fixed deposits, some of them are also good for long-term investments.

Long-term savings needs regular and disciplined investing and the fact that these products qualify for tax deduction is a sweet incentive. “Investors mostly look at long-term products in 80C and they exhaust the deduction limit primarily through life insurance policies. Investors should look at their asset allocation and look from the range of investment products instead of settling for life insurance plans alone,” said Nikhil Vikamsey, partner, Alpha Capital, a multi-family office.

Products to choose from

We pick four products from the 80C basket that you should consider.

Employees’ Provident Fund (EPF): For a salaried individual, the entry in the world of section 80C investment products begins with EPF. Every month, you and your employer contribute 12% of your salary in the EPF account. The 12% that you contribute qualifies for a tax deduction under 80C up to 1.5 lakh a year. EPF for now is returning 8.75% per annum. This is one the best products for a tax-free, risk-free return. And with the unique account number (UAN), which makes portability possible in EPF, this should be looked as a serious retirement vehicle.

Public Provident Fund (PPF): The returns on PPF have become market-linked and are pegged to government securities. The rate is declared right before the start of a financial year. For this fiscal, the rate is 8.7%. To help you exhaust your 80C deduction limit of up to 1.5 lakh, the Union budget last year also increased the maximum amount of investment in PPF from 1 lakh to 1.5 lakh.

Given the favourable tax treatment, PPF remains an attractive proposition for long-term savings, but keep your goals and asset allocation in mind.

PPF and EPF both form a part of your debt portfolio.

Equity-linked savings scheme (ELSS): If you are planning for the long term and can stomach short-term volatility that stock markets bring, equity investments are a must. You can either invest a lump sum or through systematic investment plans. ELSS comes with a lock-in of 3 years making it a short-term vehicle from the liquidity standpoint, but it is advisable to stay invested in equities for long. “You need to look at these products from the prism of asset allocation. See where you are under-invested. For equities, ELSS is your first choice and PPF for debt,” said Vikamsey.

National Pension System (NPS): NPS is designed solely for retirement savings. It’s a low-cost, market-linked product that allows you to invest every year in funds of your choice—equity, corporate bond and government securities funds. Equity exposure in NPS is capped at 50%. Given that Pension Fund Regulatory and Development Authority got its statutory power only last year, the regulations for NPS are still being written. Financial planners currently don’t recommend a high allocation to it.

Long-term products typically have longer lock-in periods directed to achieve goals of that duration.

So, before you try to use up the 1.5 lakh deduction, make sure you have an emergency fund in place and have enough for short-term goals.

The avenues to save tax don’t stop with investment products. Even your expenses, like the principal part of your home loan and health insurance policy premium can get you some relief. The tax saving process can have more benefits if you choose early, and choose with care.