The stock markets have reached dizzying heights. Risk-averse investors are rethinking their investment strategy. Interest rates are increasing and they generally have a negative impact on the stock markets.
The days of getting more than 50% returns from the stock markets are over seems to be the unanimous opinion amongst India's leading brokerage houses. Even if one were to get less than 50% returns in today's stock markets the path will be strewn with a lot of volatility they believe.
In such a scenario, we all would want to look at safe but decent returns on our investments. And it is an added advantage if these investments help us save on tax.
Section 80C and 80CCC provide for tax deduction on certain investments like the Employees' Provident Fund (EPF), Public Provident Fund (PPF), Unit Linked Insurance Plan (ULIP), National Savings Certificate (NSC), bank fixed deposit (FD) and Equity Linked Saving Scheme (ELSS).
Apart from providing decent and stable returns these savings options also help you plan and save on your tax liabilities. However, the aggregate of deductions under section 80C and 80CCC cannot exceed Rs 100,000.
Let's have a look at these avenues, their pros and cons, and what kind of risk-free returns can you get from them.
Employees' Provident Fund
This is one of the very safe investment avenues. The current interest rate of EPF is 8.5% per annum. However, this rate is not fixed and the government can modify the same from time to time. The best part of EPF is that the interest earned is exempt from tax under section 10 (12) of the Income Tax Act. That is the entire interest income earned by you goes into your pocket. The taxman gets nothing.
Investment in EPF can be made by way of a monthly contribution from your salary. The amount contributed is 12% of the total of your basic salary and dearness allowance.
Over and above this 12%, some companies allow their employees, with certain ceilings (a certain amount above which money can't be invested), to contribute an additional amount towards EPF. This is called voluntary provident fund (VPF). VPF is also eligible for tax deduction under section 80C.
You will be exempt from tax if withdrawals are done after a continuous contribution for 5 years or more, through one or more employers.
However if you withdraw money before five years the entire interest portion and the employer's contribution are taxable in the year of withdrawal. Portion of withdrawal which pertains to employee's own contribution is not taxable.
One of problems with EPF investment is that you cannot make lump sum investment into the same. The other problem is that at the time of withdrawal it often takes more than a few months to receive the money from the PF trust.
Public Provident Fund (PPF)
PPF is considered yet another safe investment avenue. The current interest rate on PPF is 8% per annum. Again like EPF the rate of interest is not fixed. The government modifies the same from time to time.
The best part of PPF is that the interest thereon is exempt from tax under section 10(11) of the Income Tax Act. Tax deduction can be claimed on contribution made by an individual into his own PPF account or into the PPF account of his spouse or children.
PPF account can be opened in a nationalised bank or a post office. It is a 15-year account. The entire amount including accumulated interest can be withdrawn after 15 years.
Partial withdrawals (which are also tax free) are allowed from the 7th year. The minimum investment amount is Rs 500 per financial year and the maximum is Rs 70,000 per financial year. The amount of investment one can make may vary every year giving you a lot of flexibility in planning your investments.
Many of you may not like to invest in PPF due to its very long tenure (15 years). However, you may open an account and contribute only small sums initially; after all minimum annual contribution is just Rs 500. In later years, contributions can be increased.
Life insurance policy (including ULIP & pension plan)
There are a variety of insurance products available. The traditional plans such as money back, cash back, endowment, whole life, children plans are considered relatively safe. However, the returns thereon vary between 4% per annum to 6% per annum. For most of these plans premium has to be paid monthly, quarterly, semi-annually or annually during the term of the policy.
The risk categorisation of ULIPs depends on the type of fund you opt for. The fund that invests its corpus mainly in equity (stocks) is considered riskier while the one investing chiefly in bonds/debentures (government debt akin to banks' fixed deposits) is considered relatively safer.
The riskier funds offer potential for high returns while safe funds offer moderate returns.
Tax deduction can be claimed on the premium paid in respect of life insurance policy of self, spouse or children.
If the annual life insurance premium were more than 20% of the sum assured then the deduction would be restricted to 20% of the sum assured. For example, if the sum assured is Rs 1,00,000 then only Rs 20,000 will be available for tax deduction.
The death benefits of the life insurance policy are exempt from tax. If the annual insurance premium does not exceed 20% of the sum assured, the survival benefits are also exempt from tax under section 10(10D) of the Income Tax Act.
Generally, it is not a good idea to invest in insurance policies. Enough has already been written on this topic and explains how the high selling, distribution and other expenses reduce the investor's returns.
National Savings Certificate (NSC)
This is also a very safe investment avenue. The certificate has a maturity period of 6 years. The current interest rate is 8.16% per annum. The interest rate is fixed in a sense that subsequent changes to the interest rates do not affect you. That is, any increase/decrease in interest rates will not have any impact on your investment or interest earned.
If you invest Rs 100 in NSC, you will receive Rs 160 after 6 years assuming an interest rate of 8.16% per annum.
One major drawback of NSC is that interest is taxable. If you are in the highest tax bracket then the post-tax return for you can be as less as 5.44% per annum instead of 8.16%.
NSCs can be purchased at any post office in your locality.
Section 80C also allows deduction on earned interest on NSC during the first five years. However, no deduction on accrued interest is available in the year in which the NSC matures.
For instance, if you earn Rs 10,000 as interest in the sixth year then it will be taxed. Interest earned during the previous five years will be tax-free.
Bank fixed deposits (FDs)
This is considered as a safe investment avenue. Certain 5-year FDs with Scheduled Banks
(Scheduled banks are those that are listed in the 2nd Schedule to the RBI Act. Most well known banks are scheduled banks) qualify for tax deduction. The interest rates vary from 7.5% per annum to 9% per annum. The interest rate is fixed in a sense that subsequent changes to the interest rates do not affect you.
One major drawback of FDs is that interest is taxable. If you are in the highest tax bracket, the post tax return for you can be as less as 5% per annum.
Equity Linked Savings Scheme (ELSS)
These are also known as tax saving mutual funds. Since ELSSs invest their corpus mainly in stock markets, these investments are considered relatively risky. However, they offer potential for high returns.
In fact, thanks to a booming Indian economy, some of the ELSSs have given over 50% annual compounded returns over the last 3 or even 5 years. In our view, for the new investors the realistic expectations should, however, be around 15% per annum.
Investment in ELSS has a lock-in period of 3 years. After 3 years, you can encash the investments at any time you want. The returns from ELSSs are in the form of dividends and/or capital gains and are exempt from tax.
Now here are a few options that may not help you get tangible returns but can surely help you in claiming tax deductions, and of course, some intangible ones.
Repayment of home loan, payment of stamp duty and registration fee and your child's tuition fee may not bring any tangible returns in the short term, but they can surely help you save on tax.
A child's education, on the other hand, will bring intangible returns when your child grows up to be a good educated person.
Repayment of home loan
Repayment of loan taken from certain agencies such as banks, home finance companies, etc. for purchase or construction of residential house or property is allowed as deduction.
Tax deduction can also be claimed on prepayments and payments. Foreclosure is premature repayment of entire outstanding loan.
Suppose you get a one-time bonus or an ESOP payment of Rs 3,00,000 and your outstanding home loan is Rs 2,50,000. And you still have two years to repay your loan.
However, if you repay this loan before that then it is a foreclosure payment or you have foreclosed your housing loan.
Deduction under section 80C is not available in respect of repayment of refinanced home loan.
Payment of stamp duty and registration fee
Payment of stamp duty and registration fees in respect of purchase of a residential house property is allowed as deduction.
Deduction is not available if the construction of the property is not completed before the last day of the financial year. That is you cannot claim any deduction for any construction or property if it is not completed before Marc 30, 2007 for this year.
Child's tuition fee
Important points are:
- Deduction is available in respect of tuition fees of up to two children of the assessee
- The tuition fees should have been paid to any school, college, university or any educational institute in India
- The fees should have been paid in respect of full time education
- The deduction is available only in respect of tuition fees
Now that you know various investment options that can give you tax free returns in these volatile times, tomorrow we will look at prioritising and sequencing your investments in a systematic manner for efficient tax saving.
ADROIT is a Pune-based firm that specialises in providing tax and investment services to individuals including non-residents. They can be reached at tax@adroitservices.in
