The tax saving season is on and both the salaried and non-salaried taxpayers would have started comparing tax saving investment options. As an investor, one should look for investment options that not only helps you save tax but also generate tax-free income.
This year, you have to keep one more thing in mind -- the income tax regime you have opted for. From FY 2020-21, an individual can continue with the old/existing tax regime by availing of existing deductions and tax exemptions. He/she also has the option to opt for the new, concessional tax regime without claiming any deductions and tax exemptions. The tax benefits one forgoes by opting for the new tax regime include deductions under: section 80C for a maximum of Rs 1.5 lakh claimed by investing in specified financial products, section 80D for health insurance premium paid, 80TTA for deduction on savings account interest earned from a bank or post office etc. (New vs existing tax regime: All you need to know)
Choosing the right tax saver
In tax-saving financial products like the National Savings Certificate (NSC), Senior Citizens' Savings Scheme (SCSS), 5-year time deposits with banks and post offices, the interest amount gets added to your income and therefore is liable to be entirely taxed.
So, even though they help you save tax for the current year, the interest income becomes a tax liability each year till the end of the tenure. "One must note that (taxable tax savers) instruments will help in saving the tax to an eligible limit both on investments and on maturity. Since they come with tax benefits, the returns on them are likely to be below the market returns," said Anil Rego, cheif executive officer and founder of Right Horizons.
The post-tax return in a taxable instrument comes down after factoring in tax. For someone who pays 30 percent tax, the post-tax return on a 5-year bank fixed deposit of 7 per cent is 4.9 per cent per annum, excluding the surcharge.
They can still be tax-exempt income if even after adding the interest income, the individual's total income remains within the exemption limit as provided by income tax rules. This tax rebate is available in both tax regimes.
With effect from FY 2019-20, an individual is eligible for tax rebate under section 87A of up to Rs 12, 500 if the next taxable income does not exceed Rs 5 lakh. This would mean that the final liability is zero if the net taxable income does not exceed Rs 5 lakh.
But, for most others especially those earning a salary or having income from business or profession, choosing tax savers that come with E-E-E status helps. The investment in these get EEE benefit i.e. exempt- exempt- exempt status on the income earned. The principal invested qualifies for deduction under Section 80C of the Income Tax Act, 1961 and the income in all of them is tax exempt under Section 10.
Here are few such tax savers that not only help you save tax but also help you earn tax-free income. But, not all are the same in terms of features and asset-class, so making the right choice is essential.
1.EQUITY-LINKED SAVINGS SCHEMES
* From April 1, 2018 any LTCG made on transfer of equity MFs that have an equity exposure of 65 per cent or more including Equity-linked savings schemes (ELSS) will have to pay a 10 per cent tax on long-term gains. It is important to note that gains made above Rs 1 lakh per annum will only be subject to tax and any gains made below that limit in one FY remains tax-exempt. The LTCG made till January 31, 2018, however, remains grandfathered, i.e., those gains remains tax-exempt.
Equity-linked savings schemes (ELSS) are diversified equity mutual funds with two differentiating features - one, investment amount in them qualifies for tax benefit under Section 80C of the Income Tax Act, 1961, up to a limit of Rs 1.5 lakh a year and secondly, the amount invested has a lock-in period of 3 years. Every mutual fund (MF) house offers them and generally uses the word tax-saving in its name to distinguish them from their other mutual fund schemes. The returns in ELSS are not fixed and neither assured but is dependent on the performance of equity markets.
One may opt for dividend or growth option in them. While the former suits someone looking for a regular income, although not assured, the latter suits someone looking to save for a long-term need.
Effective from April 1, 2020, Dividends from an equity mutual fund scheme are taxable in the hands of an investor. Hence, for someone investing in ELSS, choosing the growth option over the dividend option will yield better tax-effective returns.
To mitigate risks, one may diversify across more than one ELSS scheme (based on market capitalisation and industry exposure) after considering their long-term consistent performance. After the lock-in ends, one may continue with the ELSS investments similar to any open-ended MF scheme. However, review its performance against its benchmark before doing so. Investing in ELSS not only helps you save for a long term goal but also helps you save tax and generate tax-exempt income.
Click here to know how ELSS helps to save for retirement
2.PUBLIC PROVIDENT FUND
For decades, Public Provident Fund (PPF) Scheme has been a favourite savings avenue for several investors and is still standing tall. After all, the principal and the interest earned have a sovereign guarantee and the returns are tax-free.
PPF currently (subject to change every three months) offers 7.1% percent per annum (for the quarter ending March 31, 2021). One can open a PPF account in one's own name or on behalf of a minor of whom he is the guardian. While the minimum annual amount required to keep the account active is Rs 500, the maximum amount that can be deposited in a financial year is Rs 1.5 lakh. This is the combined limit of self and minor account.
PPF is a 15-year scheme, which can be extended indefinitely in a block of 5 years. It can be opened in a designated post office or a bank branch. It can also be opened online with few banks. One is allowed to transfer a PPF account from a post office to a bank or vice versa. A person of any age can open a PPF account. Even those with an EPF account can open a PPF account.
Under the new tax regime, an individual cannot avail tax benefit under section 80C on the contribution made to his/her PPF account. However, any interest accrued or maturity amount received from the PPF account continues to be tax-exempt in the new tax structure as well.
Whom it suits: PPF suits those investors who do not want volatility in returns akin to equity asset class. However, for long-term goals and especially when the inflation-adjusted target amount is high, it is better to take equity exposure, preferably through equity mutual funds, including ELSS tax saving funds and not solely depend on PPF.
Click here to know how PPF helps to save for retirement
3.EMPLOYEES' PROVIDENT FUND
Employees' Provident Fund (EPF) is another avenue that helps a salaried individual not only helps save tax through involuntary savings but also accumulate tax-free corpus. An employee contributes 12 percent of one's basic salary each month mandatorily towards his EPF account. An equal share is contributed by the employer but only a portion (3.67 percent) goes into EPF.
The employee's contributions qualify for tax benefit under Section 80C of the Income Tax Act, 1961, up to a limit of Rs 1.5 lakh a year but not the employer's share. Both, employee-employer share qualifies for interest as declared by the government each year which is tax-free in nature. The interest rate on EPF for FY20 is 8.5%, 8.65% for FY 2018-19, 8.55% for 2017-18.
Budget 2021 has a proposal to limit the exemption on return earned on EPF. As per the proposal, if the investment in VPF and EPF put together is above Rs 2.5 lakh in a financial year, the returns earned on the contribution above Rs 2.5 lakh will not be exempted from tax. This will come into effect from April 1, 2021 and will be applicable for FY 2021-22. Click here to read: Tax on PF interest will change the way we invest in it: How the Budget hits your PF
One may, however, increase one's own contribution up to 100 percent of basic and DA, to his VPF account and in doing so it becomes voluntary provident fund (VPF). The VPF is a part of the EPF and all the rules remain the same. The interest earned on the EPF/VPF account is tax-exempt so long as the employee continues in employment for five continuous years or more.
Although one may opt-out from VPF by intimating one's employer, the money contributed towards VPF, which represents additional savings towards retirement, get locked-in for a longer tenure, and hence use the VPF route judiciously.
Click here to know how 4 ways to check your provident fund balance
4.UNIT LINKED INSURANCE PLAN
Unit linked insurance plan (Ulip) is a hybrid product, a combo of protection and saving. It not only provides life insurance but also helps channel one's savings into various market-linked assets for meeting long-term goals.
In most Ulips, there are 5 to 9 fund options with varying asset allocation between equity and debt. A Ulip can have a duration of 15 or 20 years or more but the lock-in period is 5 years. The fund value on exiting the policy (allowed after 5 years) or on maturity is tax-free. Any switching between the fund's options irrespective of the holding period is exempt from tax.
However, the new tax proposal in the Budget 2021 has left ULIP investors anxious about this commonly used investment option giving tax free return. Going forward, if the annual premium of your new ULIP investment is more than Rs 2.5 lakh the return that you will get will no longer be tax exempt. Tax exemption shall be available under Section 10(10D) only for maturity proceed of the ULIPs having annual premium up to Rs. 2.5 lakh. In case of ULIPs having annual premium more than Rs 2.5 lakh the income/return on maturity shall be treated as capital gain and charged accordingly under section 112A, however the cap of Rs. 2.5 lakh on the annual premium of ULIP shall be applicable only for the policies taken on or after 01.02.2021.
The new taxation rule will apply only on new ULIPs so you do not need to worry about your existing ULIPs where you can keep investing the premium till maturity of the policy. Click here to read the full story.
Whom does Ulips suit: Ulips may not be suitable for all investors. Those investors who are comfortable in identifying and managing the ELSS schemes and simultaneously hold a pure term insurance plan, need not buy Ulips. Also, investors looking at investing in Ulips should make sure that the goal for which the Ulip savings is to be used is at least ten years away. For someone to exit Ulip after 5-7 years could be financially damaging.
Click here to know about 5 common sales pitch in Ulips
5.Traditional insurance plans
Traditional insurance plans could be an endowment, money-back or a whole life plan. Unlike pure term insurance plans they have a savings element in them and come with a fixed term and a fixed sum assured. The premiums are based on the age at the time of entry, the life coverage and the period for which coverage is required. Premiums are to be paid each year till maturity. Few such plans have a limited premium payment option in which premiums are to be paid only for a specified term but the policy continues for long. For example, a policy of 25 years may require premiums to be paid only for the first 5 or ten years.
While the premium paid qualifies for tax benefit under section 80C, the maturity value and the death benefit is tax-free.
The tax benefit on paying life insurance premiums to lower the tax liability under section 80C is not available in the new income tax slab structure. However, maturity proceeds received from a life insurance company continues to be exempted from tax under section 10(10D) in the new tax regime.
Where traditional plans fail: Traditional plans are inflexible in nature. The term once chosen can't be changed. For someone who has started saving for say 20 years might need funds in the 16th or 19th year. Most such plans also do not allow partial withdrawals. Even sum assured can't be changed. The traditional insurance plans including endowment, money back or of any design have a potential for lower returns and is largely in the range of 4-7 percent per annum.
6. SUKANYA SAMRIDDHI YOJANA
Sukanya Samriddhi Yojana (SSY) is a small deposit scheme for the girl child launched as a part of the 'Beti Bachao Beti Padhao' campaign. It is currently fetching an interest rate of 7.6 percent and provides income-tax benefit.
A Sukanya Samriddhi Account can be opened any time after the birth of a girl till she turns 10, with a minimum deposit of Rs 250 (Earlier Rs 1,000). A maximum of Rs 1.5 lakh can be deposited during the ongoing financial year. The account will remain operative for 21 years from the date of its opening or tuntil the marriage of the girl after she turns 18.
Click here to know how about Sukanya Samriddhi Yojana
Currently, SSY offers the highest tax-free return (7.6 percent per annum) with a sovereign guarantee and comes with the exempt-exempt-exempt (EEE) status. The annual deposit (contributions) qualifies for Section 80C benefit and the maturity benefits are non-taxable.
Individuals investing in Sukanya Samriddhi Yojana for their girl child will continue to receive tax-exempted interest in the account under the new tax regime. Further, the payment proceeds received from the scheme's account will remain exempted from tax. However, investment under this scheme will not be available for tax-break under section 80C under the new tax regime.
This year, you have to keep one more thing in mind -- the income tax regime you have opted for. From FY 2020-21, an individual can continue with the old/existing tax regime by availing of existing deductions and tax exemptions. He/she also has the option to opt for the new, concessional tax regime without claiming any deductions and tax exemptions. The tax benefits one forgoes by opting for the new tax regime include deductions under: section 80C for a maximum of Rs 1.5 lakh claimed by investing in specified financial products, section 80D for health insurance premium paid, 80TTA for deduction on savings account interest earned from a bank or post office etc. (New vs existing tax regime: All you need to know)
Choosing the right tax saver
While choosing the right tax saver, among several other factors such as safety, liquidity and returns, make sure you understand how the returns would be taxed. If the income earned is taxable, the scope to make money over the long run gets constrained as taxes will eat into your returns.
In tax-saving financial products like the National Savings Certificate (NSC), Senior Citizens' Savings Scheme (SCSS), 5-year time deposits with banks and post offices, the interest amount gets added to your income and therefore is liable to be entirely taxed.
So, even though they help you save tax for the current year, the interest income becomes a tax liability each year till the end of the tenure. "One must note that (taxable tax savers) instruments will help in saving the tax to an eligible limit both on investments and on maturity. Since they come with tax benefits, the returns on them are likely to be below the market returns," said Anil Rego, cheif executive officer and founder of Right Horizons.
The post-tax return in a taxable instrument comes down after factoring in tax. For someone who pays 30 percent tax, the post-tax return on a 5-year bank fixed deposit of 7 per cent is 4.9 per cent per annum, excluding the surcharge.
They can still be tax-exempt income if even after adding the interest income, the individual's total income remains within the exemption limit as provided by income tax rules. This tax rebate is available in both tax regimes.
With effect from FY 2019-20, an individual is eligible for tax rebate under section 87A of up to Rs 12, 500 if the next taxable income does not exceed Rs 5 lakh. This would mean that the final liability is zero if the net taxable income does not exceed Rs 5 lakh.
But, for most others especially those earning a salary or having income from business or profession, choosing tax savers that come with E-E-E status helps. The investment in these get EEE benefit i.e. exempt- exempt- exempt status on the income earned. The principal invested qualifies for deduction under Section 80C of the Income Tax Act, 1961 and the income in all of them is tax exempt under Section 10.
Here are few such tax savers that not only help you save tax but also help you earn tax-free income. But, not all are the same in terms of features and asset-class, so making the right choice is essential.
1.EQUITY-LINKED SAVINGS SCHEMES
* From April 1, 2018 any LTCG made on transfer of equity MFs that have an equity exposure of 65 per cent or more including Equity-linked savings schemes (ELSS) will have to pay a 10 per cent tax on long-term gains. It is important to note that gains made above Rs 1 lakh per annum will only be subject to tax and any gains made below that limit in one FY remains tax-exempt. The LTCG made till January 31, 2018, however, remains grandfathered, i.e., those gains remains tax-exempt.
Equity-linked savings schemes (ELSS) are diversified equity mutual funds with two differentiating features - one, investment amount in them qualifies for tax benefit under Section 80C of the Income Tax Act, 1961, up to a limit of Rs 1.5 lakh a year and secondly, the amount invested has a lock-in period of 3 years. Every mutual fund (MF) house offers them and generally uses the word tax-saving in its name to distinguish them from their other mutual fund schemes. The returns in ELSS are not fixed and neither assured but is dependent on the performance of equity markets.
One may opt for dividend or growth option in them. While the former suits someone looking for a regular income, although not assured, the latter suits someone looking to save for a long-term need.
Effective from April 1, 2020, Dividends from an equity mutual fund scheme are taxable in the hands of an investor. Hence, for someone investing in ELSS, choosing the growth option over the dividend option will yield better tax-effective returns.
To mitigate risks, one may diversify across more than one ELSS scheme (based on market capitalisation and industry exposure) after considering their long-term consistent performance. After the lock-in ends, one may continue with the ELSS investments similar to any open-ended MF scheme. However, review its performance against its benchmark before doing so. Investing in ELSS not only helps you save for a long term goal but also helps you save tax and generate tax-exempt income.
Click here to know how ELSS helps to save for retirement
2.PUBLIC PROVIDENT FUND
For decades, Public Provident Fund (PPF) Scheme has been a favourite savings avenue for several investors and is still standing tall. After all, the principal and the interest earned have a sovereign guarantee and the returns are tax-free.
PPF currently (subject to change every three months) offers 7.1% percent per annum (for the quarter ending March 31, 2021). One can open a PPF account in one's own name or on behalf of a minor of whom he is the guardian. While the minimum annual amount required to keep the account active is Rs 500, the maximum amount that can be deposited in a financial year is Rs 1.5 lakh. This is the combined limit of self and minor account.
PPF is a 15-year scheme, which can be extended indefinitely in a block of 5 years. It can be opened in a designated post office or a bank branch. It can also be opened online with few banks. One is allowed to transfer a PPF account from a post office to a bank or vice versa. A person of any age can open a PPF account. Even those with an EPF account can open a PPF account.
Under the new tax regime, an individual cannot avail tax benefit under section 80C on the contribution made to his/her PPF account. However, any interest accrued or maturity amount received from the PPF account continues to be tax-exempt in the new tax structure as well.
Whom it suits: PPF suits those investors who do not want volatility in returns akin to equity asset class. However, for long-term goals and especially when the inflation-adjusted target amount is high, it is better to take equity exposure, preferably through equity mutual funds, including ELSS tax saving funds and not solely depend on PPF.
Click here to know how PPF helps to save for retirement
3.EMPLOYEES' PROVIDENT FUND
Employees' Provident Fund (EPF) is another avenue that helps a salaried individual not only helps save tax through involuntary savings but also accumulate tax-free corpus. An employee contributes 12 percent of one's basic salary each month mandatorily towards his EPF account. An equal share is contributed by the employer but only a portion (3.67 percent) goes into EPF.
The employee's contributions qualify for tax benefit under Section 80C of the Income Tax Act, 1961, up to a limit of Rs 1.5 lakh a year but not the employer's share. Both, employee-employer share qualifies for interest as declared by the government each year which is tax-free in nature. The interest rate on EPF for FY20 is 8.5%, 8.65% for FY 2018-19, 8.55% for 2017-18.
Budget 2021 has a proposal to limit the exemption on return earned on EPF. As per the proposal, if the investment in VPF and EPF put together is above Rs 2.5 lakh in a financial year, the returns earned on the contribution above Rs 2.5 lakh will not be exempted from tax. This will come into effect from April 1, 2021 and will be applicable for FY 2021-22. Click here to read: Tax on PF interest will change the way we invest in it: How the Budget hits your PF
One may, however, increase one's own contribution up to 100 percent of basic and DA, to his VPF account and in doing so it becomes voluntary provident fund (VPF). The VPF is a part of the EPF and all the rules remain the same. The interest earned on the EPF/VPF account is tax-exempt so long as the employee continues in employment for five continuous years or more.
Although one may opt-out from VPF by intimating one's employer, the money contributed towards VPF, which represents additional savings towards retirement, get locked-in for a longer tenure, and hence use the VPF route judiciously.
Click here to know how 4 ways to check your provident fund balance
4.UNIT LINKED INSURANCE PLAN
Unit linked insurance plan (Ulip) is a hybrid product, a combo of protection and saving. It not only provides life insurance but also helps channel one's savings into various market-linked assets for meeting long-term goals.
In most Ulips, there are 5 to 9 fund options with varying asset allocation between equity and debt. A Ulip can have a duration of 15 or 20 years or more but the lock-in period is 5 years. The fund value on exiting the policy (allowed after 5 years) or on maturity is tax-free. Any switching between the fund's options irrespective of the holding period is exempt from tax.
However, the new tax proposal in the Budget 2021 has left ULIP investors anxious about this commonly used investment option giving tax free return. Going forward, if the annual premium of your new ULIP investment is more than Rs 2.5 lakh the return that you will get will no longer be tax exempt. Tax exemption shall be available under Section 10(10D) only for maturity proceed of the ULIPs having annual premium up to Rs. 2.5 lakh. In case of ULIPs having annual premium more than Rs 2.5 lakh the income/return on maturity shall be treated as capital gain and charged accordingly under section 112A, however the cap of Rs. 2.5 lakh on the annual premium of ULIP shall be applicable only for the policies taken on or after 01.02.2021.
The new taxation rule will apply only on new ULIPs so you do not need to worry about your existing ULIPs where you can keep investing the premium till maturity of the policy. Click here to read the full story.
Whom does Ulips suit: Ulips may not be suitable for all investors. Those investors who are comfortable in identifying and managing the ELSS schemes and simultaneously hold a pure term insurance plan, need not buy Ulips. Also, investors looking at investing in Ulips should make sure that the goal for which the Ulip savings is to be used is at least ten years away. For someone to exit Ulip after 5-7 years could be financially damaging.
Click here to know about 5 common sales pitch in Ulips
5.Traditional insurance plans
Traditional insurance plans could be an endowment, money-back or a whole life plan. Unlike pure term insurance plans they have a savings element in them and come with a fixed term and a fixed sum assured. The premiums are based on the age at the time of entry, the life coverage and the period for which coverage is required. Premiums are to be paid each year till maturity. Few such plans have a limited premium payment option in which premiums are to be paid only for a specified term but the policy continues for long. For example, a policy of 25 years may require premiums to be paid only for the first 5 or ten years.
While the premium paid qualifies for tax benefit under section 80C, the maturity value and the death benefit is tax-free.
The tax benefit on paying life insurance premiums to lower the tax liability under section 80C is not available in the new income tax slab structure. However, maturity proceeds received from a life insurance company continues to be exempted from tax under section 10(10D) in the new tax regime.
Where traditional plans fail: Traditional plans are inflexible in nature. The term once chosen can't be changed. For someone who has started saving for say 20 years might need funds in the 16th or 19th year. Most such plans also do not allow partial withdrawals. Even sum assured can't be changed. The traditional insurance plans including endowment, money back or of any design have a potential for lower returns and is largely in the range of 4-7 percent per annum.
6. SUKANYA SAMRIDDHI YOJANA
Sukanya Samriddhi Yojana (SSY) is a small deposit scheme for the girl child launched as a part of the 'Beti Bachao Beti Padhao' campaign. It is currently fetching an interest rate of 7.6 percent and provides income-tax benefit.
A Sukanya Samriddhi Account can be opened any time after the birth of a girl till she turns 10, with a minimum deposit of Rs 250 (Earlier Rs 1,000). A maximum of Rs 1.5 lakh can be deposited during the ongoing financial year. The account will remain operative for 21 years from the date of its opening or tuntil the marriage of the girl after she turns 18.
Click here to know how about Sukanya Samriddhi Yojana
Currently, SSY offers the highest tax-free return (7.6 percent per annum) with a sovereign guarantee and comes with the exempt-exempt-exempt (EEE) status. The annual deposit (contributions) qualifies for Section 80C benefit and the maturity benefits are non-taxable.
Individuals investing in Sukanya Samriddhi Yojana for their girl child will continue to receive tax-exempted interest in the account under the new tax regime. Further, the payment proceeds received from the scheme's account will remain exempted from tax. However, investment under this scheme will not be available for tax-break under section 80C under the new tax regime.
( Originally published on Jan 19, 2018 )
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