Where to invest to save tax

It's that time of the year when everyone starts thinking about taxes. Or rather, what to do to minimise them.

This time around, the tax payer has the going a little more easy. After all, Section 80C is certainly better than the now defunct Section 88.

Section 80C offers tremendous flexibility in determining where your money should go. 

Basically, the list of investments that qualified under Section 88 also appear in the new Section 80C. The good news is that the internal caps put on the investments have been taken out and you get to decide how much to invest where. As long as it all falls within the Rs 1,00,000 limit.

To understand the difference between Section 88 and Section 80C, read Time to do your tax planning.

Here we present the best investing options for those in their twenties.

Infrastructure bonds

This is a classic example of where you should NOT invest.

Under Section 88, everyone was virtually forced to invest in these bonds. Under the overall cap of Rs 1,00,000, Rs 30,000 was exclusively reserved for these bonds. If you did not invest in the bonds, you lost out.

This is no longer the case. Investment in infrastructure bonds falls under the overall Section 80C limit of Rs 1,00,000 with no separate cap. So you have the choice of bypassing it for another investment. Please do so.

These bonds will offer a return of around 5.5% to 6% per annum with a lock-in period from three to seven years. The returns are poor and at this stage in your life, there is no need to even consider such an avenue.

Equity Linked Saving Schemes

This is an investment you MUST consider.

ELSS are diversified equity mutual funds with a tax benefit under Section 80C. Diversified equity mutual funds are those that invest in the shares of various companies of various sectors.

Since you are young, you have time on your side to ride the ups and downs of the stock market. Moreover, stocks should be part of your investments because not only do they add that extra zing to the portfolio, but they also give the best returns over the long term.

Initially, under Section 88, there was a cap of Rs 10,000 on the investments made in ELSS. You could not invest more than that in these funds. Under Section 80C, there is no cap on this investment. If you choose, you can invest right up to Rs 1,00,000 in this investment option.

Investments in ELSS have to stay locked in for a period of at least three years. And, the returns can be great.

In 2003, these tax planning funds gave an average return of 108.97% while the Sensex rose just 72.89% that year.

In 2004, the Sensex gained just 13.08% while tax planning funds gained a little over 30%.

As on December 26, 2005, the average five year returns are 28.80% and the three year returns are 57.08%.

The best tax saving funds are Franklin India Taxshield, HDFC Long Term Advantage Fund, HDFC Taxsaver, Magnum Taxgain and Prudential ICICI Tax Plan.

To view a detailed analysis of these funds, read The best tax saving funds.

Public Provident Fund

PPF is a great long-term investment strategy.

Please do not confuse this with the EPF. Employers usually provide an Employee Provident Fund for their employees.

A percentage of the salary is deducted as Provident Fund and, generally, the employer contributes as much as the employee contributes into the fund.

Since this is automatically done, you don't need to worry about it. Your contribution to the provident fund is eligible for deduction under Section 80C.

The PPF is a government run fund where the entire contribution is voluntarily made by the individual himself.

The maximum that can be invested in a financial year (April 1 - March 31) is Rs 70,000. Here you will get a return of 8% per annum.

Your money will be locked for a period of 15 years. It may seem like a long time but will work to your benefit if you use it as a long-term retirement investment option.  

Since the minimum that you have to put in every year is just Rs 500, it is easy to maintain this investment even over a long period of time.

This is one investment that offers total safety since it is backed by the government and the return of 8% is higher than what you will get from other fixed return instruments.

So if you are going to invest significant amounts in ELSS, which are inherently risky because they are equity, you could balance your investments by also investing in PPF.

That's not all

Besides ELSS and PPF (and the provident fund contribution which is done automatically), there are other options that you must look at to save tax. Though they are not investment options per se, they must form a part of your overall investment strategy.

Tomorrow we shall look at insurance and home loan and the relevant tax benefits.