How to Maximize Savings with Tax Saving Investments

The simplest financial advice that you can get is:

Invest to increase your wealth and reduce your taxes.

It cannot get simpler than that. Can it? But it is easier said than done.

In their over-excited efforts to save taxes, people end up choosing tax-saving investment options that are unsuitable for long-term wealth creation.

Result?

They save taxes, no doubt. But they fail to create real wealth.

In this article, we analyze some of the popular investment + tax saving options for their wealth creation potential.

Section 80C to Your Rescue

Section 80C of Income Tax allows you to claim a deduction for investments made in various financial instruments.

It also allows you to claim deductions for life insurance premiums, home loan repayments, tuition fee payments, etc. (Read more about Section 80C). But these are expenses and cannot be linked to wealth building. So we focus specifically on investment options that help you create wealth.

Note 1 - There is a limit of Rs 1.5 lac on deductions that can be claimed under Section 80C.

Note 2 - Your EPF contributions too form part of Section 80C. But since this is mostly mandatory, there is no point comparing it with other options. Returns are similar to PPF returns.

Investment Options to Save Tax

1. PPF

PPF is a good option for conservative investors looking for certainty in returns.

It is one of the most popular long-term investment options that are backed by the Indian Government.

• Current interest rate is 8.0% - subject to revision every quarter
• PPF account matures after 15 years and the maturity amount is tax-free
• Amount of up to Rs 1.5 lac can be invested in a financial year - which is fully tax-deductible
• Loan facility is available and partial withdrawal is possible after 7th year

2. ELSS

ELSS or Equity Linked Savings Scheme is an open-ended equity mutual fund that invests in stocks to get higher returns.

• Good ELSS funds have given more than 15% average returns in the long term
• It offers comparatively higher returns (but not guaranteed) than all other options within Section 80C
• ELSS funds have a lock-in of 3 years and returns after 1 year are tax-free.
• Any amount can be invested in a financial year but a maximum of Rs 1.5 lac can be claimed for deduction

ELSS is a good option for investors who want high long-term returns but understand that returns might be volatile in the short-term.

3. Tax-Saving FDs

Bank FDs need no introduction. Tax-saving FDs are a variant of regular FDs that come with a lock-in.

• Interest rates range from 6-8% before taxes
• Interest is fully taxable and you have to pay taxes on interest annually even though you don’t get the interest in-hand
• After taxes, the returns are reduced substantially to 5-7% - much lower than other options

4. NSC

NSC or National Savings Certificate is a fixed income product issued by post offices and backed by the Indian government. Since its fixed-income, one can earn a predefined interest during the holding period.

• Current interest rate is 8.0%, which is compounded half-yearly but paid on maturity
• The interest rate for an NSC gets locked at the time of investment and stays the same during the holding period
• NSC matures after 5 years
• Interest earned every year is not paid out (and hence no TDS) but is reinvested. So the interest too can be claimed as deduction under section 80C. So NSC interest is taxable but becomes tax-free as it is deemed to be reinvested under Section 80C
• NSC can be purchased in denominations of Rs 100, Rs 500, Rs 1,000, Rs 5,000 and Rs 10,000

5. NPS

NPS or National Pension System is the Indian government’s defined contribution pension plan. NPS allows investors to invest in 3 options - Equity, Government Securities and other non-government Fixed Income securities.

• NPS is structured as follows:
  • Tier-I Account - Amount invested cannot be withdrawn before the investor reaches 60 years of age
  • Tier-II Account - Voluntary. Allowed only with active Tier-I accounts and withdrawals can be made as per subscriber’s requirements
• Returns are not guaranteed but depend on the allocation chosen - from amongst the three available options
• On attaining the age of 60, a minimum of 40% of the accumulated corpus has to be used to purchase an annuity. Another 40% of the accumulated corpus can be withdrawn tax-free. Rest 20% can be withdrawn in a lump sum but is taxable. Or one can even withdraw this remaining 20% over 10 years
• With so many restrictions on withdrawal, it's clear that NPS by design discourages subscribers from withdrawing their corpus
• Investments of up to Rs 1.5 lac are eligible for tax benefits under Section 80C. But this benefit is capped at 10% of basic salary
• Additional tax benefit of Rs 50,000 is offered to NPS subscribers

6. Ulips

Ulips or Unit-Linked Insurance Plans are hybrid products that combine investment with insurance.

• ULIP returns are not guaranteed but can range from 5-11% depending on the exact scheme
• Since ULIPs are generally high expense products, it takes a very long time to get good returns from these products (typically several years)
• ULIPs allow investors to switch between equity and debt components easily
• Since ULIPs mix investment with insurance, these are not an ideal investment option

7. RGESS

RGESS or Rajiv Gandhi Equity Savings Scheme was launched to incentivize small investors’ participation in stock markets. It offers certain tax breaks to first-time investors.

• 50% of a maximum investments amount of Rs 50,000 qualifies for tax benefits
• Tax benefits of RGESS are available only for first-time investors whose annual income is less than Rs 12 Lac
• One can invest in BSE100, NSE100 stocks, Major PSU stocks or RGESS mutual funds or ETFs
• Since investments are in direct stocks (and MFs that too invest in them), returns are not guaranteed

8. Sukanya Samriddhi Account

This government-sponsored scheme was launched specifically for the girl child. Sukanya Samriddhi Account (SSA) can be opened for a girl up to the age of 10 years.

• The scheme offers 8.5% returns
• The amount can be withdrawn 21 years from account opening date or when the girl gets married, whichever is earlier

So many options. Which one(s) to choose?

So many investment + tax saving options can leave you confused.

But these are not the only ones available. We have only discussed the most popular ones until now. There are others like Sukanya Samriddhi Account, Infrastructure bonds, Post-Office deposits, and whatnot.

Which investment + tax saving option is the best for you?

Before you try to find the answer to that question, remember the main aim of investing your money is not tax savings. Rather, it is to earn good returns at low risk.

There is no point in investing if the only thing you are getting is low returns with tax benefits?

Wealthy believes that the path to wealth creation should be simple and offer good returns with low risks.

There is no need to clutter your investment portfolio with several products.

So what exactly do we recommend for investment + tax savings?

If you are young and can accept short-term volatility, then you should invest in just two products:

• ELSS - Invest a major part of your investible surplus in ELSS funds that give good long-term returns.
• PPF - A smaller part of investments can be made into PPF (or EPF if your employer provides it).

This ELSS + PPF portfolio will provide you with adequate diversification as well as give you reasonably good returns in the long term. And of course, you get tax benefits of up to Rs 1.5 lac. Thank the government for that.