8 most common tax-saving instruments to cut your tax outgo
January, 05th 2015
The hike in deduction limit under Section 80C means that a taxpayer can reduce his tax outgo by up to Rs 15,000. But the higher limit may not be of much use if you don't know which tax-saving option suits you the best. Here we are grading the eight most common tax-saving instruments on the basis of returns, safety, liquidity, flexibility, taxability of income and cost of investment.
27.34% Returns (past three years)
There are compelling reasons why ELSS should be part of equity allocation in a taxpayer's investment portfolio in 2015. They may be low on safety but score full points on all other parameters. Here returns are high, income is tax free, investor is free to alter the time and amount of investment, the lock-in period of three years is the shortest among all tax-saving investments and the cost is only 2-2.5% a year. Liquidity is even higher if you opt for the dividend option and the cost gets lower if you go for the direct plans of these funds.
Smart Tip: Invest in the dividend option which acts as a profit-booking mechanism and also gives you liquidity. Dividends are tax-free.
7.8-9.7% Returns (past five years)
For a lot of people, unit-linked insurance plan (Ulip) is still a four-letter word. An ordinary Ulip is still a costly proposition for a buyer. But the online avatar of these market-linked insurance plans is a low-cost option far removed from what was mis-sold to investors a few years ago. The Click2Invest plan from HDFC Life, for instance, charges only 1.35% a year for fund management. Ulips can be used as a rebalancing tool by a savvy investor. He can switch from equity to debt and vice versa, without any tax implication. Buy a Ulip only if you can pay the premium for the full term. Also, take a plan for at least 15 years. A short-term plan may not be able to recover the high charges levied in the initial years.
Smart Tip: Don't invest in the equity fund at one go. Invest in liquid fund and then shift small
3. PPF 8.7% Returns (for 2014-15) Budget 2014 also hiked the annual investment limit in Public Provident Fund or PPF. Risk-averse investors can now stock away more in the ultra-safe scheme. PPF scores high on safety, taxability and costs but returns are not so attractive and liquidity is not very high. The scheme will give 8.7% this year, but don't count on this in the following years. The interest rate on small savings schemes such as PPF is linked to the government bond yield and is likely to come down in the coming years.
Smart Tip: Open a PPF account in a bank that allows online access. It will reduce the effort.
4. Senior Citizens' Savings Scheme
The Senior Citizens' Saving Scheme (SCSS) is an ideal tax-saving option for people above 60. The money is safe and the returns and liquidity are reasonably good. However, the interest income received from the scheme is fully taxable. Interest rate is linked to government bond yield. It is one percentage point higher than the five-year government bond yield. Unlike in the case of PPF, interest rate will remain unchanged till the investment matures.
Smart Tip: Stagger your investments in the SCSS across 2-3 financial years to avail of tax benefits.
8-11% Returns (past five years)
The New Pension Scheme (NPS) is yet to become a popular choice because of the complex procedures involved in opening an account. But investors who managed to cross that chasm have found it rewarding. NPS funds have not done badly in the past five years. The returns from the E class funds are in line with those of the Nifty, while corporate bond funds and gilt funds have given close to double-digit returns. But financial planners believe that the 50% cap on equity investments is too conservative. The other sore points are lack of liquidity and taxability of the income. The annuity income will also be fully taxable.
Smart Tip: Start a Tier II account to benefit from the low-cost structure of the NPS.
6. Bank FDs, NSCs
Bank fixed deposits, or FDs, and National savings Certificates, or NSCs, score high on safety, flexibility and costs but the tax treatment of income drags down the overall score. Interest rates are slightly higher than what the Public Provident Fund, or PPF, offers but the income is fully taxable at the slab rate applicable to the individual. FDs and NSCs suit taxpayers in the 10% bracket (taxable income of less than `5 lakh a year). The big advantage is that these are widely available. Just walk into any bank branch and invest in its tax-saving fixed deposit.
Smart Tip: Build a ladder by investing every year. After the fourth year, just reinvest the maturity amount in fresh deposits
7. Pension Plans
8-18% Returns (past three years)
Pension plans from insurance companies remain costly investments that are best avoided. Instead, it may be a better idea to go for the retirement fund offerings from mutual funds. They give the same tax benefits but don't force the investor to annuitise the corpus on maturity. S/he is also free to remain invested beyond the age of 60. Till now, all the pension plans were debt-oriented balanced schemes. Last week, Reliance Mutual Fund launched its Reliance Retirement Fund, an equity-oriented fund. However, ELSS and Ulips can be used for the same purpose.
Smart tip: Wait for the launch of retirement funds and assess their performance before investing
Traditional insurance plans are the worst way to save tax. They require a multi-year commitment and give very poor returns. The insurance regulator has introduced some customer-friendly changes but these plans still don't qualify as good investments. The only good thing is that the income is taxfree. But then, so is the income from the Public Provident Fund, or PPF, and tax-free bonds. Another positive feature is that you can easily get a loan against such policies, which gives some liquidity to the policyholder.