As the financial year draws to a close, there is a spike in investments and insurance purchases to meet income tax goals for the year. The idea is to maximise the tax deduction benefits, especially those available under Section 80C of the I-T Act, by making eligible investments and insurance purchases. However, in this rush to save taxes, people make investments that are not aligned with their financial goals or risk appetite or end up buying unnecessary insurance policies. That being said, a wide variety of tax-saving instruments, both equity and debt-oriented, fall under the purview of Section 80C, and you can make sound investment decisions provided you select the right investment vehicle.
For your investments to succeed, you need to invest in instruments that can fetch desired returns while helping you to save tax. Your investment portfolio, too, should be balanced, with investments in debt and equity for the long and short term. And while most focus on fixed income tax-savers like the Public Provident Fund, there are two other instruments that can help you meet your long-term financial goals that shouldn’t be ignored. The first is the much-discussed Equity Linked Savings Scheme (ELSS) mutual funds and the other is the often-ignored voluntary top-up to the Employee Provident Fund (EPF), called the Voluntary Provident Fund (VPF).
While both these products help you save tax under Section 80C, both are vastly different products in terms of their characteristic features, and it is essential to understand what they offer before investing.
Risk and returns
EPF is a highly secure tax-saving instrument that is currently offering returns at 8.65 per cent per annum, which is the highest returns among all similar government-backed instruments. Salaried individuals working in a company with more than 20 employees or whose salary is above the minimum stipulated amount are mandatorily required to contribute 12 per cent of their basic salary and dearness allowance (DA) into their EPF accounts. However, you can increase this contribution to as much as 100 per cent of your basic salary and DA by investing additional funds in your EPF account through VPF payments.
Do note that EPF returns are revised once in a year, unlike other small savings schemes where rates are revised every quarter. Also, there are chances its current rate of 8.65 per cent p.a. will be reduced during the next revision to be in sync with other tax-saving instruments.
ELSS, on the other hand, is a mutual fund where your money is invested in a portfolio of equity or equity-linked instruments. As a result, it can offer high returns in the long term with moderate to high risk. As a long-term investment, equity provides returns that comfortably exceed those of debt instruments, with 10- and 20-year returns of approximately 11-12 per cent on average. Despite the fact that recent returns from equities have been in the red due to a number of macroeconomic reasons, equity investments done with a long-term outlook do have the potential to mitigate risks and maximise returns.
That being said, ELSS is a market-linked product, and while returns can be higher compared to EPF, you cannot expect guaranteed returns and you should factor in your expectations from such an investment accordingly.
You can make tax-free EPF/VPF withdrawals on the completion of five years of continuous service.
However, this can be done only for specific reasons such as marriage, education, emergency medical expenses, or repayment of housing loan, and the waiting period before which you can make a withdrawal can vary depending on the purpose of withdrawal. Premature withdrawals are generally not allowed from your EPF account, and you can withdraw your entire EPF savings including interest only at the time of retirement at the age of 58 years.
The only exception to this is if you’ve given up working or want to be self-employed. ELSS mutual funds have a far smaller lock-in period of three years. You are free to liquidate your investment three years from the date of investing, though the returns may not always be as high.
Nevertheless, ELSS investments do offer you much higher liquidity, and if invested well, the short- term returns can still be high enough to beat returns from debt instruments.
Taxation of returns
Both VPF and ELSS contributions qualify for tax deduction benefit of up to Rs 1.5 lakh under Section 80C of the I-T Act.
In the case of EPF/VPF, investments made, the interest earned and the corpus withdrawn on
maturity are all tax-exempted. So, the returns from EPF are more or less real returns after tax.
However, the gains from ELSS of more than Rs1 lakh in a financial year are considered Long Term Capital Gains (LTCG) and are taxed at 10 per cent. However, this is not an immediate problem as you can smartly avoid the tax liability from ELSS gains by withdrawing gains of less than Rs.1 lakh in one year.
How to invest
Investing in VPF as well as ELSS is a very simple process. In the case of ELSS, you can purchase them online using a KYC-compliant bank account. You also have the option of buying them in a lump sum or in monthly installments via a Systematic Investment Plan (SIP). In case of VPF, you can opt in for this at any point in the financial year by submitting the VPF form to your employer and requesting them to increase your contribution towards the same.
Both EPF and ELSS are excellent options for long-term investments that should have a place in every portfolio. Either of these are instruments you can park your entire Section 80C investments.
However, the individual investor needs to decide on how much to invest in each of these taking into account their liquidity requirements and risk appetite. Also, life insurance premiums qualify for 80C tax benefits and should be a high priority for every individual who has financial dependents. Lastly, it’s great if you’ve maximised tax-benefit thresholds by making eligible investments, however, you’ll be well-advised to expand your investment horizon over tax-saving goals for adequate wealth creation. When in doubt, don’t hesitate to consult your financial advisor to help you chalk out a diversified investment plan.
The author is CEO, BankBazaar.com