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Be An Early Bird

Tax savings largely contours Section 80C investments and expenses, Section 80D for medical insurance and Section 24 for home loan interest payments.

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The last three months of every financial year see a lot of action in terms of tax savings. That is because more often than not, the tax savings process for most people only begins at the very last minute. Efficient tax planning, on the contrary, should begin at the start of a financial year. This approach helps in not only saving tax but also linking your tax saving investments to your medium- to long-term goals. The risks of making tax saving investments in a haste are manifold. From selecting an unsuitable product to ignoring the volatility or the duration could be damaging to your finance. Anil Rego, founder and CEO of investment advisory firm Right Horizons says, “Last minute rush to save taxes can cause mistakes and cash flow problems.”

The deductions available under Section 80C of the Income Tax Act of up to Rs 1.5 lakh a year includes benefits for expenses incurred as well as for investments made. The investment-related tax breaks are largely on specified investments, such as five-year notified tax saving bank deposits, life insurance premium, Employees’ Provident Fund (EPF), Public Provident Fund (PPF), National Savings Certificate (NSC), Senior Citizens’ Savings Scheme (SCSS), Equity-linked Savings Scheme (ELSS) and mutual funds (MFs). Repayment of the principal on home loan and payment of tuition fees also qualify for tax benefits under Section 80C.

Once, the investment limit under Section 80C is exhausted, one can make use of the new tax benefit introduced earlier this year. Taxpayers having exhausted their Section 80C limit of Rs 1.5 lakh a year can now look at National Pension System (NPS) to save for their retirement and in the process save additional tax. An additional deduction of up to Rs 50,000 is made available in NPS from the financial year 2015-16. For someone in the highest income slab paying 30 per cent tax rate, it’s an additional savings of about Rs 15,000 a year.

Tax Savers
Tax savings largely contours Section 80C investments and expenses, Section 80D for medical insurance and Section 24 for home loan interest payments. The other deductions include donations under Section 80G and interest payments under Section 80E for education loan, among others. When you are deciding on your investments under Section 80C, it is best to choose one from “fixed and assured returns” and “market-linked returns.” The “fixed and assured returns” tax savers are primarily debt-assets with assured and fixed income. The other, ‘market-linked returns’ category is primarily equity-asset class.

Differentiating Factors
Planning for tax savings is only a small part of the financial planning process. Rego says, “Tax planning must not be ad hoc, but be linked to financial planning goals to improve the impact of the exercise.” Identify your goals before you plan your tax savings or even make any other investment. Meeting your goals through a tax saver should act as a booster and not be the sole purpose of saving taxes. According to Rego, “Planning for future goals like down payment on home loan, higher education of children and retirement are among the areas to focus on.”

All tax saving investments have one thing in common — they come with a lock-in period ranging from 3 to 15 years or more, making them medium- to long-term products. So before locking funds, make sure your investment is linked to such a medium- or a long-term need. Consider the duration of the tax saver in deciding the right tax saver.

The other big differentiation arises in terms of the asset-class, which could be either debt or equity. If your goals are mostly medium term, then debt-based tax savers are ideal. NSC or bank tax saving deposits would be more suitable compared to PPF or insurance plans. The debt-based tax savers also suit those who are not comfortable with any kind of volatility in returns and where there is no risk of capital erosion. Plus, only the debt-based tax savers provide a fixed income thus suiting those looking for regular income.

Post-Tax Returns
The other important thing to consider while choosing a tax saver should be the post-tax returns on it. For instance, most fixed and assured return products such as NSC provides you with Section 80C benefits, but the returns — currently 8.5 and 8.8 per cent annually for 5 and 10 years, respectively — are taxable. This makes its effective post-tax returns about 6 per cent for highest tax payers. Senior citizens looking to save tax through bank tax saving deposits and SCSS should therefore carefully evaluate their tax liability before investing in them. Considering annual inflation of 6 per cent, the real return is almost zero! Of all the tax savers, only PPF, EPF, ELSS and insurance plans enjoy the EEE status i.e. the capital is tax-exempt during investing stage, growth stage and withdrawal stage.

Provident Ways
As a salaried employee, mandatory savings happens through employee provident fund (EPF), which essentially is a debt-based investment aimed towards retirement needs. EPF currently offers 8.75 per cent per annum tax-free return. One can consider PPF account as well. Given its safety — it is government backed —with relatively high returns, currently 8.7 per cent per annum, and tax exemptions on its interest earnings and the final corpus, its effective pre-tax return works out to be around 11 per cent per annum.

Market Returns

Along with tax savings if the return potential is such that it beats inflation over the long term, it’s a double bonanza for investors. ELSS, a mutual fund variant, does just that. It enjoys the most unique status of being the only tax saver with the shortest lock-in period, 100 per cent exposure to equities and above all the maturity amount is tax–free. Harshendu Bindal, president, Franklin Templeton Investments — India says, “When selecting an ELSS fund, investors need to focus on both qualitative and quantitative aspects like fund house parentage and vintage, performance track record of the scheme vis-à-vis category as well as benchmark index, experience and quality of the investment management team and quality of customer service.”

Diversify across two to three consistently performing ELSS and choose to stick with the growth option. The lock-in helps in avoiding any temptation to exit and redeem in times of volatility. At the end of the lock-in period, review the performance of the fund, state of market and choose to continue with the investment if you don’t need to withdraw the funds at that stage. “Investors also need to understand that equity as an asset class tends to be volatile in the short term. One can ride over this volatility if the investment is held for a longer period of at least five years. Preferably, an ELSS investment should be aligned to a long-term goal,” says Bindal.

Before you go looking for the right tax saver, run this simple exercise to evaluate whether you need tax saving for the current year or not

Non-80C deductions: First, look at all non-80C deductions like interest paid on home loans, health plans, educational loan. If you have a home loan or an educational loan, interest paid through EMIs will anyhow lower your taxable income

Section 80C outflows: Then, consider the Section 80C related expenses like children’s tuition fees, principal repayment on home loan. They are ongoing outflows with built-in tax benefits

Existing Section 80C commitments: Finally, consider all the existing Section 80C commitments such as Employees’ Provident Fund (EPF) and life insurance premiums. These represent existing commitments with built-in tax benefits.

The above exercise gives you a total of the existing commitments under Section 80C, 80D and other deductions. Now, from your gross total income, deduct the amount and arrive at the taxable income. To reduce taxable income further and provided the limit of Section 80C isn’t exhausted, look for the right Section 80C investments.

The recently introduced additional tax benefit under NPS could generate some interest in the product. NPS being a retirement-focused investment, allows 60 per cent of corpus to be withdrawn at the age of 60, while on balance, compulsory annuity is paid. Under present tax laws, the maturity amount and the annuity remain taxable. The maximum exposure to equities in NPS is up to 50 per cent of funds under the ‘E’ fund option which tracks the index and is thus, more of a passive fund. The returns over the last few years have been impressive for the ‘E’ fund option.

For protection needs, buy pure-term insurance plan (also qualifies for tax benefits) and diversify across PPF and ELSS to build a long-term investment portfolio spread across asset classes. The final choice of instrument should ideally be based on a gamut of factors rather than on returns from the investment product. There is no single instrument that can help you save tax and at the same time provide safe, assured and highest returns. The endeavour should be to build a portfolio that can deliver a decent return with little risk with your goals in sight.

[email protected], @dhawansunil

(This story was published in BW | Businessworld Issue Dated 25-01-2016)