Tax Saving Investments – A Detailed Guide

Deepesh Khatri
Deepesh Khatri
deepesh.n.khatri@gmail.com
tax saving
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Benjamin Franklin once said, “but in this world, nothing can be said to be certain, except death and taxes”. That statement holds true today more than ever with each of your transaction being tracked through your bank and the information collected by the government. This data is then analyzed through artificial intelligence to catch tax evaders.

The time of filing paper income tax returns is long gone and e-filing of income tax returns leaves no room for error. Then you might ask what a common man is to do to save income tax on their hard earned income. Well, the answer to that is simple, tax planning.

Tax planning can involve salary structuring for maximum tax benefits, claiming as many deductions as possible under various rules of income tax and tax saving investments. We are going to discuss the latter of the above, i.e. Tax Saving Investments.

Overview of Tax Saving Investments

Deduction of Housing Loan Repayments – Under Section 24

First House

Purchasing your first house is a great tax-saving investment a person can make. Not only does it save you rent every month, but the EMI on your first house is also tax deductible from your income. The interest component of your EMI is allowed to be set off against salary or business income (up to Rs. 2,00,000 a year); while the principal component is allowed as a deduction under section 80C (up to Rs. 1,50,000 a year). Additional deduction under section 80EE up to Rs. 50,000 a year is allowed on the purchase of the first house.

Second House Onwards

A second house is also eligible for the similar deduction under section 80C, but deduction under section 80EE is not allowed. Set off of the interest component of your EMI is fully allowed against rental income or salary or business income, but you will have to show rent from it as income which offsets the tax saving.

Best Tax Saving Investments under the Income Tax Act

Investment Avenue Returns Minimum Investment (Rs) Maximum Investment (Rs) Lock-in Period Tax Saving Benefit
Life Insurance 0 % – 10% Maximum 5 years Deduction under section 80C and exemption under section10(10D)
Health Insurance None Up to Rs. 35,000/- under section 80D
Public Provident Fund (PPF) 7.6% 500/- 1,50,000/- 15 years Deduction under section 80C
Employee Provident Fund (EPF) 8.55% Deduction under section 80C
Voluntary Provident Fund (VPF) 8.55%
Equity Linked Savings Scheme (ELSS) Linked to Stock Market Minimum 3 years
Bank Fixed Deposit 5.5% to 7.5% 500/- 5 years
Senior Citizen Savings Scheme (SCSS) 8.3% 1,000/- 15,00,000/- 5 years
Sukanya Samriddhi Scheme 8.1% 250/- Depends on Age of Girl
National Pension Scheme (NPS) 8% to 10% 500/- Post 60 Years of Age Deduction under section 80C and additional deduction under section 80CCD

*Total Deduction under section 80C is allowed up to a maximum of Rs. 1,50,000/- a year.

Brief Information about Best Tax Saving Investments

1. Life Insurance

Life insurance premium qualifies for deduction under section 80C. The maturity amount is also exempt from tax under section 10(10D) if your annual premium is up to 10% of the insurance cover. The types of life insurance plans available are:

a. Term Plans – Minimum premium and no money back.
b. Endowment Plans – Money is received at the end of the duration of the policy, a low rate of return.
c. Unit Linked Insurance Plans (ULIP) – Money is received at the end of the duration of the policy, the rate of return can be high if it is an Equity-linked ULIP.
d. Money Back Plans – Money is received at regular intervals of the duration of the policy, low rate of return.

2. Health Insurance

A health insurance premium is allowed as a deduction under section 80D. The deduction is allowed up to Rs. 25,000/- for policies covering you, your spouse and your children. Additional deduction up to Rs. 30,000/- is allowed to individuals who pay the health insurance premium for their parents who are senior citizens. So a total deduction of up to Rs. 55,000/- can be claimed by an individual under section 80D.

3. Public Provident Fund, Employee Provident Fund and Voluntary Provident Fund

Provident Fund investments are allowed as a deduction under section 80C. The rate of interest on these investments is 7.6% for PPF and 8.55% for EPF and VPF.

PPF interest and withdrawals can help you in tax saving but there is a lock-in period of 15 years.

Interest on EPF and VPF is exempt from tax and withdrawals can be made at any time. However, EPF and VPF withdrawal will be exempt only if you have been with the same employer for a minimum of 5 years.

4. Equity Linked Savings Scheme (ELSS)

Equity Linked Savings Scheme are equity-linked mutual funds, which can help you in tax saving under the section 80C. The minimum lock-in period of ELSS is 3 years. The rate of return on ELSS can vary depending on the performance of the stock market over the term of the investment.

Investments in ELSS can be made through the Systematic Investment Plan (SIP) wherein you invest a small amount at regular intervals to increase your total investment amount in a staggered manner.

5. Bank Fixed Deposit

Bank Fixed Deposits is another popular tax saving investment. Bank FDs are deductible under section 80C. The lock-in period for bank fixed deposits is 5 years. However, the interest received on these fixed deposits are taxable unlike most other investment avenues wherein the return on investment is also tax-free.

6. Senior Citizen Savings Scheme

Senior Citizen Saving Scheme (SCSS) is an investment option for tax saving available for senior citizens (individuals aged above 60 years) which is tax deductible under section 80C. The rate of return on SCSS is 8.3%. The lock-in period for SCSS is 5 years. Interest received on SCSS is taxable, unlike most other investment avenues.

7. Sukanya Samriddhi Yojana

Sukanya Samriddhi Yojana is also a tax saving avenue. It offers investments in the name of an individual’s girl child. These investments are in the form of special accounts in banks and post office. Accounts under this scheme can be opened only for a maximum of two (2) girl children and the amount deposited each year by the individual in these accounts are allowed as a deduction under section 80C.

These accounts can only be opened before the girl child turns 10 years old. Pre-mature withdrawal up to 50% of the account balance can be done when the girl child reaches 18 years of age for her higher studies. Full withdrawal can be made once the girl child reaches 21 years of age.

The rate of interest on these accounts is 8.1% and the interest received is tax-free.

8. National Pension Scheme

National Pension Scheme is a pension program for individuals. Investments in this scheme can help in tax saving under the section 80C. An additional investment of up to Rs. 50,000/- can be claimed as a deduction under section 80CCD apart from the deduction under section 80C.

You cannot withdraw money from this investment until you reach 60 years of age. The scheme does not offer a fixed rate of interest but the historical return on it has been between 8% and 10%. This interest is tax-free.

Upon reaching the age of 60, 40% of the amount in the investment is kept aside which you receive as a regular pension. Of the remaining 60%, 40% is received immediately as tax-free money and the remaining 20% is taxed as per your tax slab.

How to Choose the Best Tax Saving Investment

Choosing a tax saving investment option can be difficult for an individual who is not well versed with applicable tax laws and the time value of money. Hence, an individual should concentrate on the following factors while choosing:

1. Lock-In Period

Investments should only be made in an avenue after considering the fact whether you can keep your funds parked in it for the minimum lock-in period.

2. Rate of Return and Tax Benefits

The rate of return on investment is an important factor while deciding an investment avenue. You should also consider whether that return is tax-free or not while investing.

3. Risk Taking Capacity

Investment options like ELSS and equity-linked ULIP are linked to the stock market. Their rate of return depends on the performance of the stock market. Hence their rate of return can vary from very high to negative. A negative rate of return means that the investment made by you has reduced in value instead of increasing, thus making a loss for you.

While other investment options discussed above give a fixed rate of return between 4% and 10%.

An individual should choose an investment option depending upon their own risk-taking capacity.

Conclusion

The tax saving investment options discussed above should provide you with enough information to make a sound decision. Do remember to consider all your current and future financial needs while choosing the best option suited to you.

Deepesh Khatri
Deepesh Khatri
deepesh.n.khatri@gmail.com

Deepesh Khatri is a Practicing Chartered Accountant based in Pune. He specializes in Direct as well as Indirect Tax Matters. In his free time, he likes to read and play football.

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