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Business News/ Money / Personal Finance/  As you choose between financial instruments, how vital are tax exemptions? All you need to know

As you choose between financial instruments, how vital are tax exemptions? All you need to know

Saving income tax is one of the key factors that investors tend to weigh before opting for a financial instrument. We dwell upon its relevance in detail

Saving income tax is one of the key determinants before investors choose an investment instrument Premium
Saving income tax is one of the key determinants before investors choose an investment instrument

At the time of choosing between different investment instruments, investors tend to consider a number of factors such as the returns they give, and safety of capital they offer.

Another key factor that investors can, and should, focus on is income tax benefits these instruments stand to offer.

Some investors opt for a few investment instruments with only one goal in mind i.e., saving of taxes. These instruments include National Saving Certificate (NSC), Public Provident Fund (PPF), Equity Linked Saving Scheme (ELSS) and Senior Citizen Saving Scheme (SCSS), among others.

These financial instruments offer tax exemption under section 80C of Income Tax (I-T) Act that has a maximum cap of Rs 1,50,000 in one financial year.


There are three kinds of tax exemptions that investors can claim. The first category of exemption is given with regards to investment made in the financial instrument. The second category of exemption is given against the income received during the investment period, while the third category of tax exemption is given on the maturity amount at the end of the investment period.

The financial instruments eligible for all three exemptions are referred to as exempt-exempt-exempt. These include PPF, EPF (Employees Provident Fund), ULIPs (Unit Linked Insurance Plan) and ELSS.

In other words, an investor is entitled to receive tax exemption during all the three stages: at the time of making investment, at the time interest income is credited to their account, and finally while receiving the lumpsum at the end of the investment period.

There are some investment instruments that fall in the exempt-taxable-exempt category. This means tax exemption is given at the time of making an investment and also at the time of receiving of lumpsum but the income earned during the investment period is taxable. Tax-saving FD is one example of exempt-taxable-exempt.

Sridharan Sundaram, a SEBI-registered investment advisor and founder of Wealth Ladder Direct, advises there are two factors that should weigh in the investors’ minds before they opt for an investment instrument: one is the return post inflation, and the second is post-tax returns.

Net returns matter

Investors must calculate the net returns which they stand to receive after the pay out of income tax. “At the time of choosing a long-term investment, one must choose a mix of debt and equity which give tax-adjusted and inflation-adjusted return whereas in the short term, one must prioritise preservation of capital instead of merely trying to save tax," says Sundaram.

Apart from tax saving, investors’ risk appetite also determines the choice of financial instrument.

“Those who are willing to take risk can choose financial instruments that offer variable returns and those with a low-risk appetite can choose instruments offering fixed returns," adds Sundaram.

Just a part of it?

Investment advisors often assert that aiming for higher returns should be seen as the number one priority while saving of taxes is just one part of it.

“One should remember that investing should be the key priority while tax saving is only an element of it. Keeping tax saving as the only goal can lead to the loss of opportunities, lack of flexibility and liquidity," says Nitin Rao, Head Products & Proposition, Epsilon Money Mart.

But it doesn’t mean that saving of taxes should not be given the focus it deserves. After all, taxes can wipe out a considerable part of your earnings.

“Investors should chase both the goals of pursuing higher returns as well as savings of taxes. If you focus on only tax-saving, it is bad, and alternatively, if you focus only on higher returns, then also, it is equally bad. One should try and balance between the two," says Mumbai-based chartered accountant Chirag Chauhan.

“Taxes on income create burden on the taxpayers, hence it is important for any individual to understand their need before making any investment decisions. It is important to understand what you expect out of your investment, to achieve your financial goals or to save taxes," Mr Rao adds.

“One can optimize their investment while saving taxes through different avenues such as ELSS, PPF, NPS, life insurance plan based on their needs. The other ways to make your investment tax efficient is to hold on to your portfolio for a long time to achieve the compounding yield. One can also keep their investment in less taxable account of your family, or else offset your losses against the gains," advises Mr Rao.

One can, therefore, conclude that saving of tax and meeting of financial goals both go hand in hand. So, one should plan their investment decisions strategically without overlooking the need to save taxes.


Different ways in which capital gains are taxed in case of equity and debt funds.
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Different ways in which capital gains are taxed in case of equity and debt funds.

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Published: 10 Apr 2023, 08:35 AM IST
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