How to Invest for Tax Savings ?

Saving Tax and creating Wealth too !
The end of FY06 is arriving and most of the companies have issued timelines for employees to submit proof of Investment done for tax saving purposes. Most of us really do not really plan our tax saving avenues in a manner we think of our other Investments. It’s more of saving the taxes rather than utilizing the same money to generate higher returns.

Let’s talk briefly of the various avenues available for tax savings and find out where one should invest his or her money to get best of both worlds.

The enabling Section 80 C
One nice thing about the last finance bill was the removal of restrictions from upper limits of various investing avenues and freedom was given to invest in the eligible avenues subject to overall limit of Rs 100,000.

So, from the avenues given below, a tax payer can choose to invest in any avenue subject to a maximum investment of Rs. 100,000 to get deduction under Sec 80 C.

Avenues for Investment under Sec.80C
1. Contribution to Provident Fund
2. Repayment of Principal amount on Housing Loan
3. Payment of tution fee
4. Investment in PPF
5. Payment of Life Insurance Premium
6. Investment in NSC
7. Investment in Tax saving FD’s
8. Investment in Infrastructure development funds
9. Investment in Equity Linked Saving Schemes

Out of the above, Contribution to Provident fund is something in which most of us are already investing (deducted by employer) monthly. So out of the Rs.100,000, reduce the amount that would be deducted by the employer on account of your portion of contribution to Provident fund.

For those of us, who have school going children, Payment of tution fee is also considered for Sec. 80 C benefit.

For those who have availed of housing loan, the repayment of principal would qualify under the 1 Lac limit.

The question is how to utilize the rest of the limit (after PF, Children’s tution fee and repayment of housing loan, if any).

Investing in Government Securities
For those who seek absolute protection of their capital, Investing in Postal Saving schemes such as NSC or putting money in PPF (Public provident fund) is an option.

Public Provident Fund
This was a popular savings avenue before ELSS came into the picture. PPF offers interest income in the range of 8% with annual compounding. However, the maximum amount that can be invested in PPF is Rs.70,000 and money cannot be withdrawn before completion of 6th year. Doesn’t look exciting enough ….right ? Yes, I agree with you. However, for those who look at PPF in terms of their retirement corpus and who feel that their current PF deduction is not sufficient, they may consider this option.

National Savings Certificate
Another popular avenue of yesteryears, investing in NSC also offers a return of 8% on half yearly compounding basis. Another feature is that Interest accrued on NSC is also eligible for Sec 80 C benefit. However, with removal of Sec 80 L, NSC has lost favor since the interest income is taxable. The duration of NSC is for 6 years with a option of premature encashment after 3 years. However, that would reduce the net yield from NSC.

Tax saving FD’s
This is a relatively new kid on the block. Tax saver FD’s are issued by banks for a tenure of 5 years and premature withdrawal is not permissible. It generates interest income of 8% with quarterly compounding. The interest income is taxable. If we compare tax saving FD’s to NSC, Tax saving FD’s have an edge on lock in period which is lesser by one year. However NSC have an edge from the fact that Interest accrued is also eligible for 80 C limit.

Life Insurance and Tax savings
As far as life insurance is concerned, endowment plans (money back plans) have been a popular source of investing. However, ULIP’s have taken a center stage now since they offer insurance as well as market related returns in a single product. However, investors should understand the underlying structure of ULIP carefully since these offerings have a substantial charge towards expense in the initial years and is advisable only for investors with a large investing horizon.

Another avenue within insurance domain is Pension plans. Pension plans have got a boost in last finance bill with the overall limit raised from Rs. 10,000 to Rs. 100,000.

Let me disclose one thing here. I am biased towards other investing options as compared to Life Insurance products since I believe that insurance and investments should be taken separately. So while investing don’t think of insurance and while insuring yourself don’t think how much return you would generate from the investment in insurance. As far as insurance needs are concerned I believe in pure risk plans which cover your insuring needs at an affordable premium. However, these are my personal views and each one of you has a right to differ from this.

Infrastructure development Bonds-Losing sheen
With a return in the range of 5-6% this is the last avenue a tax saver would resort to. The dismal returns provided by these bonds have resulted in the investors shying away from these bonds. The return is hardly good enough to fight inflation, leave alone wealth creation.

ELSS –The best Tax- Savings option

Here we come to the best investing avenue for today’s investors. ELSS funds have been in limelight for their superior performance and with equity markets putting a strong and show the going is get to be good in the future too.


Why ELSS is the best Investment Strategy for Tax savings ?
1. Generates highest returns as compared to other Investing avenues

2. Provides a lock in period of Three years which is the minimum for any tax saving avenue.

3. Dividend option enables liquidity since investor gets tax free dividends during the tenure.

4. ELSS can also be seen as a way to long term investing in equity markets.

5. With India growth story unfolding and fundamentals looking intact, Investment Guru is of the view that equities would continue to outperform other investing avenues for at least next 5-7 years. Investing in ELSS provides dual benefit of capitalizing on superior returns as well as tax saving.

Why risk does ELSS pose to an Investor?
The basic risk with ELSS scheme is that since it has a considerable equity exposure, the returns are linked to market returns and hence there is no guarantee of returns and even capital.

However, I feel that this is more of a precautionary statement and needs to be reviewed in broader sense. If we choose an ELSS schemes which has delivered excellent performance in past years and has a track record of consistent results, the chance of investors loosing out would be negligible.

Choosing the best ELSS fund
Now since we have got an understanding that ELSS is a good option, let’s see how to pick a good ELSS scheme. Let’s put some filters to test the dependability of a good scheme.

1. The scheme should have an excellent track record in terms of returns generated.
2. The return generated should be seen for a 3 years timeframe since the lock in period is three years. Good returns generated on a 3 years plus timeframe would be an added advantage.
3. The returns should be delivered on a consistent basis. Hence ELSS funds with volatile returns would loose out to the one who deliver good performance year on year.
4. The fund should not have seen exodus of talent on a frequent basis. The fund should have strong processes in place to take care of management crisis.

In my next post I would highlight the Top 5 ELSS schemes which a tax payer can consider for Investing under Sec 80 C.

6 comments:

Anonymous said...

thanks rajesh sir, looking forward for the Top 5 schemes suggested by you.

hariom said...

sir g please if possible tell your views soon as the last date is approaching.......

Rajesh Soni said...

Hi Hariom
I believe you query is addresse. I have posted the Top 5 ELSS schemes.

Anonymous said...

Hi,

Please guide me where to invest. I have jotted down my understanding and requirements:

In current financial year, PF and ULIP (ICICI Prudential) takes care of Rs. 50,000
Out of the following - Where to invest rest Rs 50, 000?
1)Jeevan Aastha (LIC)
2) LIC (other Policies)
3) PPF
4) FD
5) Mutual Funds (ELSS)

I belong to a middle class family and have no savings/bank balance till now.
Last year I invested Rs20, 000 (SBI magnum tax saver ), Rs 20, 000 (Reliance tax Saver) , Rs 25, 000 (ULIP-ICICI Prudential- for 3 years locking).

Request you to kindly suggest where to invest money to take the maximum benefits in terms of returns; as well as it should be a save investment.
I would really appreciate a quick reply.

MANISH said...

Rajesh sir I am a Govt.Employee and ihave invested in PACL 12000/- per annum for the term of Five and half year.Will u please tell me is it comes under section 80(c) and will give me benifit in tax?

amit said...

PACL.....If it is the one which was in news for the scam, then I am afraid that your investments are not eligible for 80C benefits.