Growing Wealth while Saving Taxes
It is that time of the year once again when we start thinking about our tax savings for the year and scramble to do last minute tax saving investments before the financial year ends. While we cannot eliminate taxes completely, a smart investor can surely cut down on the overall tax outgo by prudent tax planning. One important section for tax savings is the 80 C wherein one can save taxes up to Rs. 46800.
Given the substantial tax savings that one can make, it surely generates a lot of interest. The options are many under this category and choosing the most suitable one is what requires some thought. Many choose these investments with little thought and end up getting stuck with unwanted and unsuitable investments. What can make a difference is using these options wisely to not only save tax at the time of entry but also linking them up to your long term financial goals.
What is easier said is difficult in practice, especially given the sheer number of options. Should one choose the Staid old fixed deposit or go for PPF? Would it be better to choose a ULIP or an ELSS? Then there is the question of lock ins. Should one choose the higher lock ins or the shorter ones suit us better? Post maturity taxability is another factor to choose on. The choices are hard and given that one has to practically do it every year, choosing the most suitable one that will not only save taxes but also create wealth over long term is an important decision to take.
Let us have a quick peek on the common ones on offer and their unique features of returns, safety, flexibility, liquidity, costs, transparency, ease of investment and taxability of income. This will surely help one to decide and choose the best option
ELSS(Equity Linked Savings Scheme):
Equity linked saving scheme or ELSS is a type of mutual fund scheme that primarily invests in stock market or equity. The advantage of ELSS over other tax saving instruments is the shortest lock in period of 3 years and attractive returns with lower taxes post maturity. Since the past 5 years, ELSS have given a return of 16.5%*. While the low lock in and high returns make this an attractive option, one needs to be careful about the high volatility that the markets present. A staggered approach can cut on the volatility to a large extent.
NPS: Though there is a long lock in, the additional tax savings that these offer make it an attractive option. One can save Rs. 15600 as taxes in addition to the 80C. 60% of returns withdrawn after the age of 60(can be extended upto 70) are tax free and the rest are received as taxable annuity.
ULIPS: The long term tax benefit that one gets on ULIPs makes it an attractive option for most investors and possibly this is the biggest selling point of these instruments. However, one has to factor in the possibility of lower returns, long lock ins and mis selling. Sold as an instrument that offers tax free returns, an investor needs to understand that the returns are tax free only if the insurance cover is more than 10 times the investment made and this would obviously come at a cost in terms of lower returns. Also contrary to being pitched as a 5 year product, the entire tenure of the investment has to be seen through to get the full benefit.
PPF(Public Provident Fund):
Amongst the small savings, this instrument scores the best of giving 7.1% return and that too tax free. Ideal for those looking for safety of their corpus. This however comes with a long lock in of 15 years which makes it unsuitable in terms of liquidity. A PPF account may be opened in your bank or the post office.
Senior Citizens’ Savings Scheme:
Offering a return of 7.4%, this is possibly one of the best returns that one can get on their investments, especially for senior citizens. This also gives the advantage of regular returns paid out quarterly and taxed at the tax slab. Also one can claim the additional exemption of Rs. 50000 as interest income under the new tax rules. The limit of investment that one can make here is only 15 lakhs and individuals over 60 years of age can only apply.
Sukanya Samridhi Scheme:
If you have a daughter who is less than 10 years of age, then this is a perfect way to save on taxes while creating a healthy corpus for her education/marriage. This offers a return of 7.6% which may change every quarter. One can open accounts in the post office or the bank.
5 year bank deposit: Possibly one of the most common but most unsuitable options given the low returns, lock ins and the taxability of returns. Safety of corpus is what drives people to invest in this option, but it would be worthwhile to keep in mind that this safety comes at a cost. The returns are barely able to beat inflation and are tax inefficient.
Traditional Life Insurance Policies: These remain the worst way to save taxes. With costly premiums that give very poor coverage, these investment vehicles are high on charges and low on returns. They are also highly illiquid and mis sold as guaranteed return products.
As most people go about the ritual of investing in tax saving instruments year after year, what they fail to factor in is that this is a powerful tool to create wealth over long term. If chosen wisely, the per year compulsory investment of Rs.1.5 lakhs has the potential to meet financial requirement of our children and even our own retirement and all this while saving taxes on our income too!
Let us understand this with an illustration.
Let us assume that you are a 30 years old and want to grow wealth while saving on taxes. We shall take an investment period of 15 years.
Instrument Amount invested over 15 years* Value of investment* Multiplication factor Post Tax
5 year FD 22.5 36.53 1.64 32.15
ELSS** 22.5 84.6 3.76 78.30
PPF 22.5 40.20 1.79 40.2
ULIP** 22.5 47.65 2.12 47.65
*figures in lakhs **returns have been assumed
So this year be different and be informed as you go about choosing your tax saving measures and most importantly make it count!
The choice of investment will surely depend on individual needs and requirements. It would be worthwhile to discuss same with your financial advisor who can advise on the basis of your financial goals and other parameters.
Cheers to an Informed Investor!
Anupama Bhargava
CFP
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