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More Is Not Better

Author: Shivram Yedithi/Tuesday, February 23, 2010/Categories: Tax

More Is Not Better

For salaried employees, January-March period is perhaps the busiest time to plan the last-minute investment in tax-saving instruments. However, most people don’t look at tax planning as part of a larger financial planning process. In order to avoid last-minute rush and investment glitches that may arise, one should start planning for tax savings early.
It is also commonly observed that people feel they can save up to 1 lakh under 80C and thus they have to invest Rs 1 Lakh every year. However, the fact is for most salaried employees, PF contribution is already a part of Section 80C and whatever is remaining is the maximum one can save for tax. Apart from these one can also explore other opportunities where additional amount can be saved.
Let us discuss in brief some of the investment opportunities available under various sections for tax saving:
Provident Fund (EPF/ VPF): It is important for one to check the PF contribution in the financial year to arrive at a figure which is required to be invested to avail full benefits under section 80C.
Repayment of Housing Loan (Principal): If one has a home loan, the principal repaid in the financial year attract tax benefit. For most people, PF and Home loan principal takes care of the most of the Rs 1 Lakh limit. Further, for people having home loan, the interest amount up to Rs 1.5 Lakh for the self-occupied and the entire interest amount for rented flat is deducted from the salary.
Life insurance premium payments: This is an important investment not only for the purpose of saving tax but also to ensure your dependants have all the facilities to ensure their well being in unwarranted circumstances. It is advisable to go for this early in one’s career to not only to save tax but also because the premiums are much lower for young people.
Public Provident Fund (PPF): PPF is an investment wherein one can contribute a minimum of Rs 500 to a maximum of Rs 1 lakh in an assessment year. These have a lock-in period of 15 years and attract interest of around 8.70%. This can be opened with any nationalized bank or post office. The interest is compounded annually. After the maturity this account can be further extended for 5 years. This is a reasonable investment option as if one has a PPF account, whatever is the shortfall in the initial declaration submitted can be fulfilled using this subject to a minimum of Rs 500. This can work as a good last minute option to bank upon.
5-Year fixed deposits with banks and post office: Fixed deposits with a 5 year lock in attract tax benefit. The interest rates, however varies from bank to bank and can be a difficult option to explore at the eleventh hour.
Tuition Fees: Tuition fees of up to two children for education can has benefits under section 80C. This does not include donations and school development fees.
Unit Linked Insurance Plan (ULIP): ULIP is a type of product with life insurance coverage with the value of investment varying with the NAV of the scheme. If carefully chosen by considering charges and Investment style, it can be a very good Investment with Life coverage and also benefits under section 80C.
Equity Linked Savings Scheme (ELSS): If someone is looking for tax savings coupled with better potential returns and lower lock-in then ELSS is a very good option to explore. ELSS schemes are mutual funds which are professionally managed and contain investments in equity which presents with an opportunity of higher than inflation returns when compared to other investments with 80C benefits. 
Also, these have a lock in period of 3 years unlike most other with lock-in of 5 Years or more. Since they are held for a span of 3 Years, it presents with an opportunity for the fund manager to pick stocks backed by good fundamentals and deliver returns over the period of holding. Also, considering the markets have been negative to range bound for more than 5 years and with elections around, the markets may gain some momentum and if it is backed by positive developments in domestic as well as global markets, this time may be considered as an apt time for ELSS investments.
ELSS funds have a lock in since they come under tax saving schemes, and have two options of growth and dividend to choose from.  It depends on the investor suitability and his/her expectations to choose dividend or growth plan. Growth plan gives a chance for investment to have compounded growth but capital along with appreciation is available only at the end of lock-in period, while dividend plan provides with a chance to get a part of appreciation in the form of dividends which are tax free at the hands of investor.
At maturity or completion of 3 years of lock-in one can redeem and reinvest and again save on tax with the same amount. This can be used to lessen the burden on the pocket of the investor.
“ELSS is useful for short term tax savings as lock-in is for 3 years... Also for those who would require deduction under 80C, ELSS is the right product as it is covered under 80C and tax benefit can be claimed for current financial year,” says Rashmi Roddam, Director, WealthRays group.
Let’s understand it with an example. Say, an investor invests Rs 25000 in year 1, 2 and 3. In the fourth year the year 1 funds would be released and can be reinvested for another tax benefit. Similarly, year 2 investment can be reinvested in year 5 and year 3 investment in year 6. And this cycle can go on. While one is able to take advantage of the 80C in every year, from fourth year onwards the burden on the pocket of the investor can come down.
Apart from the above investments under section 80C, there are various other sections under which you can invest in order to save tax. 
Health Insurance u/s 80D: It’s a very useful investment in health insurance plan and one can save an additional tax under section 80D. The premium, which is paid for medical insurance policy for self and family members to protect them from sudden medical expenses, comes under this section.  The maximum amount allowed for exemption annually for self, spouse and children is Rs 15,000. Additional tax benefit of Rs 15000 or Rs 20000 can be availed if a health insurance is bought by you for your parents who are not senior citizens or senior citizens respectively.
Rajiv Gandhi Equity Savings Scheme (RGESS) u/s 80CCG: For additional tax savings one can look at other avenues such as Rajiv Gandhi Equity Savings Scheme (RGESS) where one can save additional Rs 25,000 u/s 80 CCG. An individual with a total income less than Rs 12 Lakh, who is a first time investor, who has never invested in stocks or derivatives or who has freshly opened a demat account. Such people can invest up to Rs 50,000 in eligible securities to save an additional tax on up to a Maximum of Rs 25,000 over and above Rs 1 lakh u/s 80C. In the recent budget it has been decided to extend the tax benefits for the “first time investors” investing in the eligible securities or eligible mutual funds for not only one year but for 3 years. However, there is a lot of confusion with regard to the investment guidelines hence advisable to take help from an advisor.
First time home buyers: In the Union Budget, it has been proposed to give Rs 1 Lakh additional deduction from gross income to first time home buyers on loans up to Rs 25 Lakh. However attractive it may be, many people might not be able to take advantage considering the upper limit of Rs 25 lakh as it is difficult to find houses in that range.
Section 80G: Donations to charitable institutions or NGO’s are deducted as an additional amount from the income u/s 80G.

Avoid Pitfalls
There are some common pitfalls taxpayers make while making last-minute investment in tax-saving instrument. These include buying insurance without taking into consideration adequacy of risk cover and without understanding terms & conditions; investing in ULIPs as last-minute option to save tax without knowing charges, lock-in and other market driven conditions applicable to the product; and, investing in products just for the sake of saving tax for current year without knowing its past performance and importance of such investments in their portfolio based on their risk appetite.
“Plan for your contingency expenses before investing for tax planning as tax saving instruments will be locked in for a minimum of 1 year to 15 years; it should not happen that you will not be left with enough cash when actual requirement arises,” says Roddam.

 

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