One should understand that tax planning is the most crucial aspect of financial planning. It has to be employed very wisely for the creation of wealth and realization of absolute financial dreams. It's just a matter of investments to claim tax exemption on income up to Rs. 1,50,000 under Sec 80C of Income Tax Act, 1961 without considering their suitability or returns by most taxpayers. They forget that tax planning is a part of the overall financial planning that helps to aid their investment goals, build wealth, and achieve financial freedom. Points to be considered are the suitability, liquidity, risk appetite, returns, transparency, the ease of making investments, etc. A few investment options to save tax are discussed below.
Sufficient life insurance cover is a must for a person with dependents. It will be best to buy a term plan covering insurance costs with no returns attached to it with a higher sum assured at a very affordable premium. With any unfortunate event, the nominee will get a vast death benefit from the insurer, which can be used for financial planning for the deceased's dependents and obtain regular cash flows.
Include equity in the investment portfolio for creating wealth in the long term. ELSS are mutual fund schemes managed by professional fund managers that invest in equities across sectors and provide tax exemption and have the shortest lock-in period of 3 years. None of the other tax saving options will provide these features like ELSS. Historically ELSS have provided equal returns like best-performing equity mutual funds and should be a preferred option as tax saving investment than others.
EPF is available to the salaried class, an excellent tool with limited withdrawal options for retirement planning that earns an interest rate of 8.5% p.a (for F.Y. 2020). Every month, 10-12% of the employee’s basic salary and an equal contribution from the employer are deposited in the employee's EPF account.
EPF is an exempt-exempt-exempt (EEE) product, which means investment made qualifies for a tax deduction, interest earned on the investment is also tax-free, and the final corpus amount withdraw on maturity is also be tax-free.
PPF is available to the general public if he is salaried or not. It is having a 15-year lock-in period with an option to renew for another block of another five years. Minimum and maximum limits of investment per financial year are Rs. 500 and Rs. 1,50,000, and one can get an interest rate of 7.1% (for F.Y. 2020-21) with the EEE feature. one can opt for a partial withdrawal after the 6th year. A person can take a loan against the balance in the PPF account.
The government of India launched NPS in January 2004. It is a contribution-based pension scheme mandatory for central government employees (but not for armed forces) appointed after January 1st, 2004. Any Indian citizens between the ages group of 18 and 55 can contribute to NPS. The scheme has two tiers in its structure:
Tier 1: No premature withdrawals are allowed before the age of 60
Tier 2: Withdrawals allowed
The minimum investment is Rs. 6,000 in a financial year. The investment is deployed in three asset classes:
Equities-maximum of 50%
Government Securities-minimum of 20%
Fixed Income Securities-minimum of 10%
The fund management charges are 0.25%, which is the lowest in the industry. Contributions made towards Tier 1 will qualify for deductions under Section 80CCD (1) and Section 80CCD (1B). One can invest up to Rs. 2 lakhs, i.e., Rs. 1.50 lakh under Sec 80CCD (1) and Rs. 50,000 under Section 80CCD (1B) in an NPS Tier 1 account and claim a tax deduction for the full amount. On maturity, 60% of the corpus can be withdrawn as a lump sum without any tax. One can buy an annuity
with the remaining 40%.
A person can claim 100% withdrawal if the total accumulated corpus is less than or equal to Rs. 2 Lakh at superannuation/attaining age 60.
The subscriber can opt for full withdrawal of the accumulated corpus if it is less than or equal to Rs. 1 Lakh. But, one can exit from NPS only after the completion of 10 years.
A phased withdrawal facility is also available for which he can take the lump-sum amount in a phased manner up to 10 installments, over a period from 60 years (or some other retirement age given by the employer) to 70 years.
Many individuals with a low-risk appetite and looking for guaranteed returns use the option of investment in tax-saving F.D. with a minimum lock-in period of five years. They can get an exemption under Sec 80C of the Income Tax Act, 1961.
A brief comparison of a few tax-saving instruments is presented in the tabular format below:
| Tax saving instrument | Contribution | Duration | Returns % FY 2020 | 80C benefit | Tax treatment |
|---|---|---|---|---|---|
| Life insurance | Based on sum assure | As opted till age 65-70 | N.A. | Yes | EEE |
| ELSS | Min Rs 500 | 3-year lock-in | Market linked | Yes | ‘0' if gains below 1 lakh, over and above 1 lakh LTCG tax of 10% |
| EPF | 10-12% of salary | Till retired | 8.5 | Yes | EEE |
| Min Rs 500 max 150000 | 15-20 years | 7.10% | Yes | EEE | |
| NPS | Min Rs 6000 | Tillage 60 | Market linked | Yes | EET |
| Tax saving five years FD | Min Rs 500 max 150000 | Five years | Individuals 5.3-6.95 Senior citizens 5.8-7.45 | Yes | EET |
A rule of thumb for equity allocation is 100 minus a person’s age. One at his 20 or 30s can go as high as 70%-80% to equities, and as he grows older, it can be reduced and moved to safer investments. When an individual retires at 55 or 60, equity allocation can be 40% - 45% to build capital against inflation.
Consider points like a person’s age, goals, time horizon, lock-in period, etc., while choosing suitable tax-saving instruments without compromising financial planning goals and saving taxes.
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Mutual fund investments are subject to market risk. Read the scheme related documents carefully.