Even in the peak winter, many taxpayers are sweating. As they scurry to complete their tax planning for the year, they are dogged by dilemmas. ELSS have earned good returns, but when the Nifty PE is at 40, future performance is usually poor. NPS has exclusive tax benefits, but the lock-in extends till retirement. PPF is safe but its lock-in period is also quite long. Tax-saving fixed deposits and NSCs have shorter lock-in periods but tax on interest means the post-tax returns are very low. Ulips have lowered their charges and offer tax-free income, but you are stuck with the same insurer for the entire tenure.
This week’s cover story attempts to resolve these dilemmas for taxpayers. Like in the past, we have assessed 10 tax-saving instruments on eight key parameters—returns, safety, flexibility, liquidity, costs, transparency, ease of investment and taxability of income. Each parameter is given equal weightage and the composite scores of the various options determine their ranking.
ET Wealth ratings
ELSS: 5 stars
They have the potential to give high returns, are flexible and easy to invest in. But overvalued markets are a worry right now.
NPS: 5 stars
The pension scheme offers additional tax benefits as also flexibility to switch. But liquidity may be an issue for some investors.
Ulips: 4 stars
Once the most missold investment, Ulips have reformed. They come with low costs, tax-free returns and flexibility of switching.
PPF: 4 starsThough the returns are tax-free, interest rates have gradually moved southwards. The floating rate could decline further.
Sr Citizens’ Saving Scheme: 3 stars
By far the best option for retirees that offers decent returns and regular income. But ranks low due to limited scope.
Sukanya Yojana: 3 stars
Offers higher interest than PPF and same tax treatment, but the limited scope and restrictions are a damper.Pension plans: 3 stars
Might be a good option for saving for retirement, but these plans cannot match the NPS on costs and tax benefits.NSCs: 2 stars
Consistent fall in government bond yields have pulled down interest rates and the ranking of this ultra-safe option.Tax-sa ..
Tax-saving FDs: 2 stars
Offer very low returns and income is fully taxable. But this is the easiest way to save tax if you don’t have time.Life insurance policies: 1 star
The purpose of life insurance is protection, not saving tax. Tax saving is additional feature, not core benefit.
The ranking alone is not a guide. We have also explained the pros and cons of each tax-saving option to help readers invest in the one that suits them best.1. ELSS
Our rating: 5 stars
Returns: 13.2% in past three yearsELSS funds score high on almost every parameter. They have the potential to give high returns, have the shortest lock-in period of three years, regularly disclose their portfolios and have fairly low costs. They are also very tax friendly—the 10% long-term capital gains tax kicks in only on gains beyond `1 lakh and regular harvesting of capital gains can reduce the liability to a great extent. What’s more, investing in these funds is very easy if you are already KYC compliant. It can be done online in a matter of minutes through all fund houses and the investing portals that have mushroomed in recent years.
However, the big worry for investors is that markets are at hyper inflated levels even as the economy is expected to shrink by 7.7% this year. The macroeconomic numbers raise questions about the sustainability of the rally that has taken benchmark indices to all-time high levels. Investing a large amount in equity funds at one go is not a good idea when the Nifty is trading at a PE of 40, especially when you can’t touch that money for three years.
Returns are annualised; data as on 13 Jan 2020 Only funds with AUM of over Rs 1,000 crore considered Source: Value Research
Experts say that investors who stagger their purchases over time and invest with a long-term horizon need not worry. But staggering the amount across 2-3 monthly SIPs is not an option for taxpayers who have to show proof of Sec 80C tax-saving investments in a few days. Keep in mind that ELSS funds are essentially equity schemes and carry high risk. It’s bes ..
Choosing the right fund is also critical. Many ELSS funds have done well in the past three years, but the category average is not very impressive. Also, don’t make the mistake of opting for the dividend option, which can push up your tax liability since dividends are now added to income and taxed at the normal slab rate.2. National Pension Scheme
Our rating: 5 stars
Returns: 11-14.3% for past five years
NPS helps save tax under three different sections. Firstly, contributions of up to Rs 1.5 lakh can be claimed as a deduction under the overall Sec 80C. Besides this, there are two tax benefits exclusive to the NPS. There is an additional deduction of up to Rs 50,000 under Sec 80CCD(1b). Also, if the employer contributes up to 10% of the basic salary of the individual in the NPS under Sec 80CCD(2), that amount is tax free.Apart from these tax advantages, the NPS allows investors to choose their as set mix (and even make changes) besides changing their pension fund manager. And its fund management charges of 0.01% (or Rs 10 per Rs 1 lakh investment) are perhaps the lowest among all market-linked instruments. In the long term, even a small difference in the costs can have a significant impact on the maturity corpus of the investor.
One problem is the long lock-in period. Except in case of specific emergencies, NPS investments cannot be withdrawn till the taxpayer attains the age of 60 or retires. Many taxpayers may not want to lock up their money for such long periods. The compulsory annuitisation of 40% of the corpus on maturity is another bugbear for investors, although many financial planners perceive this as a positive feature that ensures lifelong pension for the individual.
NPS funds have had a very good run in the past few years due to the twin rallies in stocks as well as bond markets. But while the equity markets are expected to correct, the decline in bond yields may now reverse. The long-term bonds held by gilt funds will lose value if interest rates go up. Experts say it is better to move from gilt funds, where the average duration of bonds is 8.2 years, to corporate bond funds, where the average duration is 4.5 years, making them less sensitive to interest r ..
3. Ulips
Our rating: 4 stars
Returns: 8-12.5% for past three yearsUlips score high in our ranking because income from insurance plans is completely tax free under Sec 10(10d). But this tax exemption is subject to certain conditions being met. The insurance cover should be at least 10 times the annual premium. This tax-free aspect has become more significant after long-term capital gains from equity investments were made taxable two years ago. While gains beyond a Rs 1 lakh from equity funds are taxable, income from Ulips remains tax free. Moreover, switching from equity to debt or vice versa in a Ulip does not have any tax implications, making a Ulip an ideal instrument for rebalancing the portfolio.
But Ulips have their shortcomings as well. Their charges have come down drastically, but the structure is still opaque. Some of the charges are built into the NAV while others are levied by deducting units. Check all charges before you buy. Ulips also score low on flexibility. Once you buy, you are stuck with the same insurer for the rest of the term. You can’t switch to another insurer. Also, you have to continue paying the premium for a minimum period. Otherwise the plan is discontinued and th ..
4. Public Provident Fund
Our rating: 4 stars
Returns: 7.1% for Jan-Mar 2021 quarterThe PPF scores high on safety, flexibility and taxability. There is also ease of investment. An account can be opened in a Post Office branch or designated branches of PSU banks. Some private banks also offer the facility to invest in the PPF. The tenure of the scheme is 15 years from the first investment. On maturity, this can be extended in perpetuity in blocks of five y ..
What investors must note is that small saving schemes have floating rates of interest. The interest rates are linked to government bond yields and are changed every quarter. The benchmark 10-year bond yield has been declining consistently and is now below 6%. But this is not reflected in the rates of small savings schemes, which have remained unchanged for three quarters. Unless interest rates move up and bond yields rise, the government will eventually have to cut small savings interest rates.
Financial advisers say the tax-free nature of the PPF makes it better than fixed deposits. However, they also point out that those covered by the Provident Fund could earn higher returns if they opt for the Voluntary Provident Fund. But that can be done only in the next financial year. For this year, go for the PPF. It is an investment in which you can’t ever go wrong.
|
