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Tax-saving is a year-long business
November, 06th 2007

Tax-saving is a year-long business. This is because the returns matter as much as the tax saved through the investment.

Death and taxes are a certainty. But, financial planning takes care of both.

As far as taxes go, major tax-saving instruments are a contemplated deduction of Rs 1 lakh under section 80 C of The Income Tax Act 1961.

This may not be the season of writing about tax-saving option for those used to undertaking the process in the last quarter of the financial year. But, the scenario has changed today and investors are planning their tax affairs and consequent investment considering the investment potential, too. Gone are the days when an investment in tax-saving bonds, life insurance policies and other assured-return instruments sufficed.

Generally speaking, any investment should be weighed in three contexts: Security/ risk, liquidity and returns. Investment not secured or risk not understood and managed has its own pitfalls, while liquidity ensures availability of funds at the time of necessity. As for returns, they should be strong enough to beat inflation and fulfil other financial objectives. Hence, one should necessarily apply all these tests before choosing the tax-saving option.

Under section 80C, there are different types of tax deductions available, some of which are:

Life insurance premium, eligible assesses being individuals/ HUFs

Sum paid under contract for deferred annuity

Contribution to Employees Provident Fund

Contribution to Public Provident Fund (PPF)

Contribution to Recognised provident fund

Contribution to approved superannuation fund

Subscription to any notified security or notified deposit scheme of the central government

Contribution to Unit Trust of India for unit linked insurance plan

Principal repayment for housing loan

Subscription to any notified saving certificates

Subscription to any unit of any notified mutual fund or the Unit Trust of India, etc

PPF: A popular investment, it still has die-hard takers. At present, it gives 8 per cent tax-free returns, which is as good as pre-tax returns of over 11 per cent for an individual in the highest slab of 30 per cent. It is fully secured and rewards guaranteed and timely returns. However, the scheme is not very liquid and is for a period of 15 years, further extendable by 5 years. Withdrawals are possible only from the seventh year.

Insurance: This is more a necessity than investment. An insurance cover, irrespective of the tax need, should be carefully assessed as per the life stage of a person and other factors such as family, childrens needs, earning levels, encumbrances, etc, the more because it is generally for a very long tenure and there is a compulsion to pay at regular intervals.

It is advisable to separate insurance from investments. Any insurance product has, apart from mortality charges, a very high administrative cost, which also applies to the investment component. Term insurance can be the most appropriate and necessary instrument for a young family with kids. The majority of investors are seen to have taken insurance covers that mature between 50 and 60 years of age, when the real mortality risk begins.

Also, insurance is very illiquid as an investment. Security-wise it is fine but gives very less returns, though the maturity amount is tax-free. Now-a-days, Ulip is very popular, but it has the drawback of various charges.

Equity linked savings scheme (ELSS): ELSS is a tax saving mutual fund. If the risk tolerance of an investor permits, it is an ideal savings instrument for wealth creation. It scores very well on the count of liquidity, though there is a 3-year lock-in period. Further, dividend plan can also start giving you tax-free returns immediately. As maturity is not before 3 years, it becomes a long-term capital gain and hence tax-free.

And although termed as risky and not guaranteed, historically it has given very good returns with a time horizon of 3 to 5 years and is an ideal instrument for both tax-saving and fulfilling ones financial objectives. The risk can be managed and mitigated by opting for a systematic investment plan. It is a smooth way to ride the volatility of the stock markets. However, those who are retired and have bare minimum funds and less risk tolerance should not consider it.

National Savings Certificates (NSC): This is also a popular savings instrument managed by the Post Office. Interest income from the same is taxable because the deduction under section 80 L is withdrawn. As the span of certificate is 6 years, it is not that liquid but very secured because it is issued by the government.

Fixed deposits (FDs) with scheduled banks: From the accounting year 2007-2008, FDs with scheduled banks for 5 years are also eligible for tax-saving deductions. This form of investment is very suitable for retired persons or widows or someone who has no risk appetite. It is comparatively liquid as it is for a period of 5 years only and due to recent rise in interest rate, also gives decent return. However, interest receivable is taxable and returns are not exciting.

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