BEST WAYS TO SAVE TAX PART 2
Multiple
options. Contradictory advice. And a deadline that’s approaching fast. Many
taxpayers find themselves in this situation at the beginning of the year
when they have to make tax-saving investments. Are you also confused? Before
you make a choice, go through our cover story to know which is the best
option for you. We have ranked 10 of the most common investments under
Section 80C on five basic parameters: returns, safety, flexibility,
liquidity and taxability.
Every investment has its pros and cons. The PPF may
not have a very high return, but its taxfree status, flexibility of
investment and liquidity by way of loans and withdrawals, gives it the
crown in our beauty pageant. Equity-linked saving schemes come in second
because of their high returns, flexibility, liquidity and tax-free status.
However, traditional insurance policies, an all-time favourite of Indian
taxpayers, manage the ninth place because of the low returns they offer and
their rigidity.
Some readers might be surprised that the much
reviled Ulips are in the third place. The Ulip remains a mystery and its
returns are seldom tracked. We checked Morningstar’s data on Ulips and
found that the returns have not been very good in the past 1-5 years. Even
so, it can be a useful instrument for the smart investor who shifts his
money between equity and debt without incurring any tax.
We have tried to separate the chaff from the grain
by assigning a star rating to the various tax-saving options. Whether you
are a novice or a seasoned investor, you will find it useful. It will help
you cut through the clutter and choose the investment option that best
suits your financial situation.
VOLUNTARY PF
RETURNS: 8.5% (for 2013-14) This little used option is available only to
salaried taxpayers covered by the Employees’ Provident Fund.
The contribution to the Employees’ Provident Fund
(EPF) is a compulsory deduction, as also an automatic tax saver. However,
you can contribute more than 12% of your basic salary that flows into the
EPF every month. This voluntary contribution will earn the same rate of
interest, will fetch you the same tax benefits under Section 80C and the
maturity corpus will also be tax-free.
A key disadvantage is the limited liquidity that
the Provident Fund offers. You cannot access the money till you retire. A
one-time withdrawal is allowed in special circumstances, such as medical
emergency, purchase or construction of a house, or a child’s marriage.
However, it may not be possible to opt for the VPF
at this juncture. Companies typically ask their employees to submit the VPF
mandate at the beginning of the financial year. Ask your company if you can
start contributing to the VPF from this month onwards. Once you have opted
for the deduction, you cannot discontinue it till the end of the financial
year, except in extraordinary circumstances.
While the VPF gets tax deduction and the maturity
corpus is also tax-free, you will have to pay tax on the interest if you
withdraw the money within five years. So, opt for it only if you are sure
that you can remain invested for the long term.
Another drawback is the possibility of a lower
interest rate for the PF in the coming years. The rate is announced by the
EPFO Trust after examining the interest earned by the EPF corpus. It is
likely to be 8.5% for the current financial year, but there is no certainty
that this will be maintained over the longer term. Contributing to the VPF
is suitable for taxpayers in their 50s, who want to aggressively save for their
retirement but don’t want to invest in marketlinked options or
tax-inefficient fixed deposits.
BRIGHT IDEA
Channelise at least 10% of your increment to the VPF every year. The
higher savings will not pinch you.
SENIOR CITIZEN’S SAVING SCHEME
RETURNS: 9.2% (for 2013-14) This remains the best way for retirees to
save tax, though the `15 lakh investment limit is a damper.
With four stars, this assured return scheme is the
best tax-saving avenue for senior citizens. However, the `15 lakh investment
limit somewhat curtails its utility as a tax-saving option. The interest
rate is 100 basis points above the 5-year government bond yield. Unlike the
PPF, the change in interest rate does not affect the existing investments.
This year, the interest rate has been cut by a marginal 10 basis points to
9.2%.
Many grey-haired investors may not be enthused by
this. Banks are offering up to 10% to senior citizens right now, almost
50-60 basis points higher than what they give to regular customers. There’s
a good reason for this pampering. Senior citizens have a bulk of their
investments in fixed deposits, which makes them prized customers for banks.
So, if you do not consider the tax deduction under Section 80C, this option
is not as lucrative as bank FDs.
However, as a tax-saving tool, the scheme scores
over bank fixed deposits and NSCs because the quarterly payment of the
interest provides liquidity to the investor. The interest is paid on 31
March, 30 June, 30 September and 31 December, irrespective of when you
start investing. This aspect of the SCSS, and the fact that it is an ultra
safe scheme backed by the government, makes it an ideal option for retired
taxpayers looking for a steady stream of income. Though the interest earned
is fully taxable, retired people usually don’t have a high tax liability.
Keep in mind that the basic tax exemption for senior citizens is higher at
2.5 lakh. For very senior citizens, it is even higher at `5 lakh.
The only glitch is the `15 lakh investment limit per
individual. If a person parks `15 lakh of his retiral benefits in the
scheme, he will be able to claim deduction for only `1 lakh.
Although the scheme is for senior citizens (60
years), even those above 55 years can invest if they have taken voluntary
retirement. Retired defence personnel can join irrespective of their age if
they fulfil other conditions.
BRIGHT IDEA
If you have 15 lakh to invest in the scheme, stagger the investments
over 2-3 years to claim more tax benefits.
NEW PENSION SCHEME RETURNS:
4.2-10.2% (past 3 years)
The low-cost retirement product is a good option fro those saving for
retirement, but watch out for the limited liquidity it offers.
Its low-cost structure, flexibility and other
investor-friendly features make the New Pension Scheme an ideal investment
vehicle for retirement planning. However, even though the fund management
charges have been raised from the ridiculously unviable 0.0009% to a more
reasonable 0.25%, the pension fund managers are not hardselling the scheme.
If you want to save tax through the NPS this year, be ready to do a lot of
legwork and paperwork before you can get to invest in this unique pension
plan.
The returns from the NPS funds are a mixed bag (see
table). While the returns from the E class (equity) funds are in line with
the market returns, those from the G class (gilt) funds are quite a
disappointment. Government employees, who have a chunk of their pension
funds in the G class schemes of LIC Pension Funds and SBI Pension Funds, would
be especially hit. The redeeming feature is the high returns churned out by
the C class (corporate bond) funds. However, these bonds carry a higher
risk.
The scheme scores high on flexibility. The minimum
annual contribution is 6,000, which can be invested as a lump sum or in
instalments of at least `500. There is no upper limit. The investor also
decides the percentage of the corpus that goes into equity, corporate bonds
and government securities, the only limitation being the 50% cap on exposure
to equity.
One of the most outstanding features of the NPS is
the ‘lifecycle fund’. It is meant for those who are not financially aware
or can’t manage their asset allocation themselves. It is also the default
option for someone who has not indicated the desired allocation for his
investments.
Under this option, the investor’s age decides the
equity exposure. The 50% allocation to equity is reduced every year by 2%
after the investor turns 35, till it comes down to 10%. This is in keeping
with the strategy to opt for a higher-risk, higher-return portfolio mix
earlier in life, when there is ample time to make up for any possible black
swan event. Gradually, as the investor approaches retirement, he moves to a
more stable fixedreturn, low-risk portfolio.
This automatic rejigging of the asset allocation is
a unique feature of the NPS. No other pension plan or asset allocation
mutual fund offers such a facility to investors. There are a few funds
based on age, but they are one-size-fits-all solutions, not customised to
the individual’s age.
Another positive feature of the NPS is the wide
choice of funds for the investor. Though you can switch from one fund
manager to the other only once in a
year, it is still better than investing
in a Ulip or a pension plan where you are stuck
with the same fund manager for the rest of the tenure. IDFC Pension Fund
quit the NPS last year, but two well-regarded entities—HDFC Pension Fund
and DSP Blackrock Pension Fund—have joined the club. Another unique feature
of the NPS is the tax benefit it offers under the newly added Section 80
CCD(2). Under this section, if an employer contributes 10% of the salary
(basic salary plus dearness allowance) to the NPS account of the employee,
the amount gets tax exemption of up to `1 lakh. This is over and above the
`1 lakh tax deduction under Section 80C.
It’s a win-win situation for both because the
employer also gets tax benefit under Section 36 I (IV) A for his
contribution. By putting in money in the NPS, the employer can provide an
additional tax benefit to the employee by simply reorganising the salary
structure without incurring any additional cost to the company (CTC).
The wart in the NPS is the lack of liquidity. You
cannot access the funds before you turn 60. On maturity, at least 40% of
the corpus must be used to buy an annuity. Some see this as a positive
feature that prevents premature withdrawals.
BRIGHT IDEA
Get your company to opt for the Section 80CCD(2), under which you can
save more tax trhough the NPS.
NSCs AND BANK FDs RETURNS:
8.5-9.75%
They appear attractive, but taxability of income takes away some of the
sheen from these instruments.
There are many misconceptions about bank fixed
deposits in the minds of investors. Many think that up to `10,000 interest
from bank deposits is tax-free, as announced in the budget two years ago.
This is not true. The newly introduced Section 80TTA gives a deduction of
up to `10,000 on interest earned in the savings bank account, not on fixed
deposits and recurring deposits. Also, the nomenclature ‘tax-saving
deposits’ means you save tax under Section 80C. It does not mean that these
deposits are tax-free. The interest earned on deposits is fully taxable at
the normal tax rate applicable to you. You have to mention this interest
under the head ‘Income from other sources’ in your income tax return.
Keep in mind that this tax is payable every year on
the interest that accrues in that financial year, even though you get the
amount on maturity. So don’t get misled by the high interest rates offered
on the 5-year bank fixed deposits. The posttax yield may not be as high as
you think. In the 20% and 30% income tax brackets, it is not as attractive
as the yield of the tax-free PPF.
The second misconception is that there is no need
to pay tax if TDS has been deducted by the bank. You may have to pay tax
even if TDS has been deducted. TDS is only 10% (20% if you haven’t
submitted your PAN details), and if you are in the 20-30% bracket, you need
to pay additional tax.
Ignore mentioning the interest income in your
return at your peril. The TDS is credited to your PAN and reported to the
tax authorities. If there is a mismatch in the TDS details in the tax
records and in your return, you will surely get a tax notice. The Central
Board of Direct Taxes has a computeraided scrutiny system (CASS), which
flags any discrepancy in the tax return filed.
Check the TDS in your Form 26AS, which has details
of the tax deducted on your behalf. It can be easily checked online. It is
easier if you have a Net banking account with any of the 35 banks that
offer this facility. Otherwise, you can go to the official website of the
Income Tax Department and click on ‘View your tax credit’. The first-time
users will have to register, but it takes less than 5 minutes to log on and
view your details.
The interest on NSCs is also taxable but very few
taxpayers include it in their returns. However, with the integration of tax
records, a taxpayer may not be able to escape the tax net easily. For
instance, if you have claimed tax deduction under Section 80C for
investments in NSCs or FDs in one year, the tax department may want to know
why the interest earned is not reflecting in your tax returns for
subsequent years.
BRIGHT IDEA
Don’t try to avoid the TDS by investing in FDs of different banks. You
will have to pay the tax later anyway.
 
LIFE INSURANCE POLICIES RETURNS:
5.5-7.5%
Despite the revised guidelines, insurance plans are still not a
good investment. Only HNI investors will find the tax-free corpus
appealing.
Though the Irda guidelines for traditional plans
have made insurance policies more customer-friendly by ensuring a higher
surrender value and larger life covers, they are still the worst way to
save tax. The tax saving is only meant to reduce the cost of insurance. It
is not the core objective of the policy.
Money-back and endowment insurance policies score
low on the flexibility scale. Once you buy a policy, you are supposed to
keep paying the premium for the rest of the term. This can be a problem if
you took the policy only to save tax.
However, these policies are not as illiquid as they
appear. You can easily get a loan against your endowment policy from the
LIC. The terms are quite lenient and repayment can be done at your
convenience.
Insurance companies claim their products offer the
triple advantage of life cover, long-term savings and tax benefits. That’s
not true. Traditional plans give a low life cover of 10 times the premium.
For a cover of 25 lakh, you will have to spend 2.5 lakh a year. They also
give niggardly returns. The internal rate of return (IRR) for a 10-year
policy comes to around 5.75%. For longer terms of 15-20 years, the IRR is
better at 6.5-7.5%. As for the tax benefit, there are simpler and more
cost-effective ways to save tax, such as 5-year bank FDs and NSCs. If the
taxability of the income worries you, go for the tax-free PPF.
However, traditional insurance policies still make
a lot of sense for the HNI investor who is more concerned about the
tax--free corpus under Section 10(10d) than the deduction under Section
80C. Even for such investors, a Ulip will make more sense as they will have
control over the investment mix. The opacity of the traditional plan is
best avoided, but your agent might not be very keen to sell you a Ulip this
year because his commission has been cut to 6-7% of the premium.
PENSION PLANS RETURNS: 7-10%
After a hiatus of 2-3 years, pension plans are making a comeback, but the
high charges mean lower returns for investors.
Pension plans offered by life insurance companies
made a comeback in 2013. However, the charges of these plans are
significantly higher than those of the NPS. While the NPS has a fund
management charge of 0.25%, a typical pension plan from a life insurance
company charges almost 3-4%. This difference can snowball into a wide gap
over the long term, reducing the returns of the pension plan investor by a
significant margin.
Insurers argue that the low-cost NPS is good only
on paper because there are so many hurdles to investing in the scheme. A
pension plan from an insurer is costlier but you don’t have to go around in
circles trying to invest in it. That’s true to a great extent. Even after
four years of launch and offering additional tax benefits, the NPS has not
been able to attract investors in hordes. However, the solution is not a
highcost pension plan.
A few mutual funds also have pension plans. The
Templeton India Pension Plan is one of the oldest schemes in the market and
offers deduction under Section 80C. It is a debt-oriented fund that invests
30-40% of its corpus in equities and the rest in debt. But at 10.7%, its
5-year annualised returns are nothing to gloat about.
A better option would be a combination of an ELSS
scheme and any of the debt instruments that offer tax deduction.
BRIGHT IDEA
It is not a good idea to invest a large sum in the equity option at one
go. Opt for the liquid or debt fund instead.
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