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10 best tax-saving investments
January, 06th 2014

Contradictory advice. And a deadline that's approaching fast. Many taxpayers find themselves in this situation at the beginning of the year when they have to make tax-saving investments.

Are you also confused? Before you make a choice, go through our cover story to know which is the best option for you. We have ranked 10 of the most common investments under Section 80C on five basic parameters: returns, safety, flexibility, liquidity and taxability. Every investment has its pros and cons.

The PPF may not have a very high return, but its tax-free status, flexibility of investment and liquidity by way of loans and withdrawals, gives it the crown in our beauty pageant. Equity-linked saving schemes come in second because of their high returns, flexibility, liquidity and tax-free status. However, traditional insurance policies, an all-time favourite of Indian taxpayers, manage the ninth place because of the low returns they offer and their rigidity.

Some readers might be surprised that the much reviled Ulips are in the third place. The Ulip remains a mystery and its returns are seldom tracked. We checked Morningstar's data on Ulips and found that the returns have not been very good in the past 1-5 years. Even so, it can be a useful instrument for the smart investor who shifts
his money between equity and debt without incurring any tax.

We have tried to separate the chaff from the grain by assigning a star rating to the various tax-saving options. Whether you are a novice or a seasoned investor, you will find it useful. It will help you cut through the clutter and choose the investment option that best suits your financial situation.

This all-time favourite became even more attractive after the interest rate was linked to bond yields in the secondary market. The PPF is our top choice as a tax saver in 2014. It scores well on almost all parameters. This small saving scheme has always been a favourite tax-saving tool, but the linking of its interest rate to the bond yield in the secondary market has made it even better. This ensures that the PPF returns are in line with the prevailing market rates.

This year, the PPF will earn 8.7 per cent, 25 basis points above the average benchmark yield in the previous fiscal year. The benchmark yieldhad shot up in July and has mostly remained above 8.5 per cent in the past six months. Although the yield is unlikely to sustain at the current levels, analysts don't expect it to fall below 8.25 per cent within the next 2-3 months. So it is reasonable to expect that the PPF rate would be hiked marginally in 2014-15.

The PPF offers investors a lot of flexibility. You can open an account in a post office branch or a bank. However, the commission payable to an agent for opening this account has been discontinued, so you will have to manage the paperwork yourself. The good news is that some private banks, such as ICICI Bank, allow online investments in the PPF accounts with them. There's flexibility even in the quantum and periodicity of investment.

The maximum investment of Rs 1 lakh in a year can be done as a lump sum or as instalments on any working day of the year. Just make sure you invest the minimum Rs 500 in your PPF account in a year, otherwise you will be slapped with a nominal, but irksome, penalty of Rs 50. Though the PPF account matures in 15 years, you can extend it in blocks of five years each. However, this facility is no longer available to HUFs.

The PPF also offers liquidity to the investor. If you need money, you can withdraw after the fifth year, but withdrawals cannot exceed 50 per cent of the balance at the end of the fourth year, or the immediate preceding year, whichever is lower. Also, only one withdrawal is allowed in a financial year.

You can also take a loan against the PPF, but it cannot exceed 25 per cent of the balance in the preceding year. The loan is charged at 2 per cent till 36 months, and 6 per cent for longer tenures. Till a loan is repaid, you can't take more. If you dip into your PPF account, be sure to put back the amount at the earliest. Withdrawing from long-term savings is not a good strategy if you do it frequently. It can dent your overall retirement planning.

The PPF is especially useful for risk-averse investors, self-employed professionals and those not covered by the Employees Provident Fund and other retiral benefits.
BRIGHT IDEA: Invest before the 5th of the month if you want your contribution to earn interest for that month a The potential for high returns, wide choice of funds and flexibility make these funds a good tax-saving option for equity investors.

Equity-linked saving schemes (ELSS) have the shortest lock-in period of three years among all the tax-saving options under Section 80C. However, this should not be the most important reason for investing in this avenue. Being equity funds, these schemes can generate good returns for investors over the long term. In the past five years, this category has created wealth for investors with average returns of 17.5 per cent.

However, this potential to earn high returns comes with a higher risk. There is no guarantee that your investment will generate positive returns after the 3-year lock-in period. The category has generated an average return of 2 per cent in the past three years. Even the best performing funds have churned out disappointing returns. The returns will naturally mirror the performance of the stock markets. Therefore, only investors who have the stomach for a roller-coaster ride should consider this option.


Should investors avoid ELSS now, especially since the stock market is close to its all-time high? Not really, because the stock market has returned to the previous high after a 6-year gap and, therefore, is not overvalued at all. "Since the stock market is reasonably valued now, ELSS should generate good returns for investors who can remain invested for 5-7 years," says Gajendra Kothari, managing director and CEO, Etica Wealth Management.

Though the large-cap Sensex and Nifty are at higher levels, the mid-cap and small-cap indices are at much lower levels. This means there is enough value in midcap stocks, which should help the fund managers do well in the coming years. Selecting the right scheme is crucial since there is significant variation in the returns of different schemes.

Though past performance is an important parameter, also take into account the track record of the fund house and fund manager. Once you select a scheme, decide whether you want to go for the dividend or growth option. There is no difference in the tax treatment of the two options The potential for high returns, wide choice of funds and flexibility make these funds a good tax-saving option for equity investors.

Equity-linked saving schemes (ELSS) have the shortest lock-in period of three years among all the tax-saving options under Section 80C. However, this should not be the most important reason for investing in this avenue. Being equity funds, these schemes can generate good returns for investors over the long term. In the past five years, this category has created wealth for investors with average returns of 17.5 per cent.

However, this potential to earn high returns comes with a higher risk. There is no guarantee that your investment will generate positive returns after the 3-year lock-in period. The category has generated an average return of 2 per cent in the past three years. Even the best performing funds have churned out disappointing returns. The returns will naturally mirror the performance of the stock markets. Therefore, only investors who have the stomach for a roller-coaster ride should consider this option.

Should investors avoid ELSS now, especially since the stock market is close to its all-time high? Not really, because the stock market has returned to the previous high after a 6-year gap and, therefore, is not overvalued at all. "Since the stock market is reasonably valued now, ELSS should generate good returns for investors who can remain invested for 5-7 years," says Gajendra Kothari, managing director and CEO, Etica Wealth Management.

Though the large-cap Sensex and Nifty are at higher levels, the mid-cap and small-cap indices are at much lower levels. This means there is enough value in midcap stocks, which should help the fund managers do well in the coming years. Selecting the right scheme is crucial since there is significant variation in the returns of different schemes.

Though past performance is an important parameter, also take into account the track record of the fund house and fund manager. Once you select a scheme, decide whether you want to go for the dividend or growth option. There is no difference in the tax treatment of the two options has too much equity, avoid investing in these funds.
BRIGHT IDEA: Don't invest a lump sum. Split investments in ELSS funds into three SIPs starting from January till March.

RGESS: An avoidable option for the first-time equity investor The RGESS allows first-time equity investors earning up to Rs 12 lakh a year additional tax savings under the newly introduced Section 80 CCG. If you invest in the RGESS options, you can claim a deduction of 50 per cent of the invested amount. The maximum investment is Rs
50,000, so the maximum deduction availed of can be Rs 25,000. This is over and above the Rs 1 lakh limit available under Section 80C.

The scheme permits investments in the BSE-100 or CNX 100 shares, shares of Maharatna, Navratna or Miniratna PSUs, or in designated equity mutual funds and ETFs. Should you invest in it to avail of this benefit? We would not advise investing directly in shares just to claim tax deduction. In fact, the first-time investors are better off taking the mutual fund route.

If you do opt for any RGESS fund or ETF, your investment is locked in for three years (fixed lock-in period during the first year, followed by a flexible lock-in period for the two subsequent years). Under the flexible lock-in option, you are allowed to sell your RGESS shares or mutual funds units and reinvest the proceeds in any other RGESS instrument. This will enable you to get rid of the underperforming investments and shift to better options. However, in the absence of an SIP facility, you are exposed to market timing.

Also, the maximum tax saving you can get through this scheme is Rs 7,725 for those in the 30 per cent income tax bracket. In the 20 per cent bracket, the maximum saving is Rs 5,150, while you save only Rs 2,575 in the 10 per cent bracket. This is not much considering the risk you are taking by investing in

 
 
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