Reducing taxes as much as possible is at the forefront of our minds. The all-powerful Section 80 C offers the best way to this, as most of you know. But what are the ways to utilise the Rs 150,000 worth of deductions that the section provides?
Broadly, deductions under Section 80C fall into three groups – those based on investing, those based on protection, and those based on spending. For the purpose of wealth creation, obviously, the options that incentivise investments are the ones that matter. You have choice aplenty in this regard. Here’s listing them out.
Investments can be of two types – one, where the return is fixed (like a bank deposit) and one where it isn’t (read: equities).
Equity-linked-savings-scheme or ELSS, also called tax-saving funds, are mutual funds that invest in equity (in other words, the stock markets). ELSS funds have a lock in period of three years, the shortest of all tax-saving instruments. There are over 40 tax-saving funds on offer across fund houses. Dividends are not taxed, nor are proceeds at the time of withdrawal. These instruments are thus EEE – exemption allowed at the time of investment, exemption of income earned from tax, and exemption at the time of withdrawal.
ELSS returns depend on both the stock market, given the inherent vagaries, and the fund manager’s expertise. But given that equities are the most superior asset class when considered over the longer term, investing in quality tax-saving funds are much more conducive to building long-term wealth than the traditional tax-saving options which are fixed-income instruments. ELSS is also more amenable to early liquidation, unlike the provident fund triumvirate. Some AMCs also have equity-based pension funds, which are tax-deductible.
The other tax-deductible instrument that has an equity component is the NPS. Apart from the Section 80C ceiling, an additional Rs 50,000 worth of investment under Section 80 CCD is allowed for the NPS. A very low-cost product, the NPS is locked in until you turn 60 as it is meant to build your retirement corpus. The NPS requires minimum contributions of Rs 6000 per year.
Investment in the NPS is split between equity, corporate debt, and government debt – how much goes into what depends on your choice. You also have to choose the fund manager that will manage your investment; there are six managers currently. When you turn 60, you can pull out up to 40 per cent of the corpus and the rest will be moved to an annuity product. However, all withdrawals will be taxed.
All other investment-based tax deductions are fixed income instruments.
First, there is the employee provident fund (EPF). This is one investment that the salaried class will usually have. Your employer deducts a defined sum from your salary each month (12 per cent of basic pay plus dearness allowance), which goes into the EPF. Your employer’s matching contribution is not considered for 80C deductions.
Second, there is the voluntary provident fund (VPF). Over and above the EPF amount, you can contribute a further proportion of your salary, termed the VPF. This contribution goes into the EPF pool. Note that in a VPF, there is no similar contribution from your employer – it’s entirely your own investment. The EPF and VPF are regulated by the EPFO (Employee Provident Fund Organisation). The interest rate payable each year is declared by the EPFO, and your interest is compounded. The rate for 2014-15 stands at 8.75 per cent. You are locked into the investment for the period of your employment.
Three, there is the public provident fund (PPF), where you can invest any sum you want up to a maximum of Rs 150,000 a year. There is no periodicity of investment here, unlike EPF or VPF. Nor is it deducted from your salary. You have to make the investments yourself at designated bank branches or the post office. Once you start a PPF, you must make the minimum Rs 500 contribution each year. The PPF is regulated by the PFRDA, which also declares the interest rate each year. PPF is locked in for 15 years, extendable after that in five-year buckets.
Interest earned on PPF, EPF, and VPF is not taxed. Proceeds at the time of withdrawal is not taxed either, making them EEE instruments.
Then there are time deposits in various hues. 5-year tax-saving bank deposits, which pay a fixed interest as declared by each bank, are one. Then there is the 5-year post office time deposit, which pays, currently, an annual interest of 8.5 per cent. Specific term deposit schemes of public sector companies such as NABARD, NHB, or HUDCO are also available.National Savings Certificates come in time buckets of five and ten years. Interest on the NSC is currently 8.5 and 8.8 per cent per annum, respectively..
However, on all these schemes, the interest earned is subject to tax. The tax effect, therefore, reduces their overall return even though the actual rates themselves are reasonably high. For example, the post-tax returns of a five-year NSC works out to 7.9, 7.1, and 6.3 per cent in the 10, 20 and 30 per cent tax brackets.
The options listed above are open to all (barring EPF, of course, as it is only for the salaried class). Besides those, there are a couple of other options in which only a few can invest.
One of these is the Sukanya Samriddhi account, which can be opened if you have daughters. Up to two accounts can be opened, up to the age of 10 years from the date of birth. The rate of interest will vary each year just as PPF or EPF interest, but is currently 9.2 per cent per annum, compounded yearly. The minimum yearly (and mandatory) contribution is Rs 1,000. Partial withdrawal of the corpus is allowed after the daughter turns 18, and the account can be closed after she attains 21 years of age. Proceeds at withdrawal and the interest are both free from tax.
Another is Senior Citizens Savings Schemes, open, obviously, to those above 60 years of age. The rate of interest is right now at 9.3 per cent payable quarterly. These deposits have five-year maturities and can be opened at post offices. Interest is, however, taxed.
The sum of Rs 1.5 lakh accounts for a good chunk of your total yearly savings. Knowing which investments qualify for tax deductions, their lock-in periods, and how their returns can be will help you make an informed decision about where to save tax this year.