INDIA INCOME TAX Best ways to save Tax
Choose the tax-saving instrument that best suits your needs and financial goals.
So many options, so lit tle time. If you have still not completed your tax planning for 2016-17, don't panic.ET Wealth's annual ranking of tax saving instruments cuts through the clutter and tells you which is the most suitable option for you.The ranking assesses all the investment options on eight key parameters--returns, safety, flexibility, liquidity, costs, transparency, ease of investment and taxability of income. Each parameter is given equal weightage and composite scores are worked out for the various tax-saving options.
For many investors, ease of investing becomes paramount because they don't have much time.Fixed deposits score very high on this front. Just a few clicks and your investment is done. Insurance agents also make the process very easy. They volunteer to do all the paperwork and the investor has to just sign on the dotted line.But the cost of this ease is very high. In the 30% tax bracket, the post-tax returns from fixed deposits are less than 5%. And traditional life insurance plans not only offer niggardly returns, but force the buyer to continue till maturity.
Investors who are ready to make a little effort will find it very rewarding. Investing in ELSS funds has now become very easy with the launch of the e-KYC facility. The whole process does not take more than 30-35 minutes.The Pension Fund Regulatory and Development Authority has made NPS investing completely paperless. Ulips can also be bought online with ease.
A word of advice. Don't go by the ranking alone. Some investment options may not be suitable for certain individuals. For instance, even though ELSS funds can offer terrific returns, senior citizens above 70 should steer clear of these schemes. They are better off investing in the Senior Citizens' Saving Scheme, the Public Provident Fund or tax-saving fixed deposits, even though these safe and secure options figure lower in the ranking.
Some of the options on our list may not even be available to all investors. For instance, the Sukanya Samriddhi Yojana is open only to girls below the age of 10, the Senior Citizens' Saving Scheme is only for those above 60 (58 years in some cases) and only those below 60 can invest in the National Pension System (NPS). Even so, these are good tax-saving options for those who are eligible.
The great returns they have generated in the past and their enormous poten tial have placed ELSS funds at the top of the list for the third consecutive year. The category has generated 18.69% annualised returns in the past three years and 17.46% in the past five years. The returns from individual funds vary because each fund has a different portfolio. For instance, Franklin India Taxshield has a decidedly large-cap orientation with 81% of its corpus allocated to largecap stocks. Investors can expect stable returns without any fireworks. On the other hand, Reliance Taxsaver has more than 50% of its portfolio in midand small-cap stocks, which has helped it generate outsized returns from it. An investment of `50,000 made in the direct plan of the fund in January 2014 would have almost doubled to `97,700 in three years. Four of the five schemes in our list of top ELSS funds are large-cap oriented funds. Only Birla Sun Life Tax Relief 96 has a mid-cap orientation.
The high returns are not the only plus point. ELSS funds also score high on costs, transparency, taxability and liquidity. There is no entry load and the investor is charged barely 2.5-2.75% a year (direct plans charge even less). Mutual funds are very well regulated by Sebi and everything--charges, port folios and transactions--are in the public domain. Returns are tax free because long-term capital gains from equity funds are exempt. As for liquidity, these funds have the shortest lock-in period of three years.However, this lock-in period should not be construed as the holding period for the fund. Many investors make the mistake of exiting after three years (see box). This is why the ELSS category continues to see low net inflows from investors.
Some experts say ELSS funds are the best way to start investing in equities. The lock-in period enforces a discipline that eventually becomes a habit for the investor. Investors such as Pune-based Chandrasekharan Hariharan (see picture) will find ELSS the ideal stepping stone into equity investments. As we have often said, SIPs are the best way to invest in equity funds.This way you are able to diversify across time. However, given that we are already in the last quarter, you may not be able to invest in ELSS through SIPs now. Still, split your investment into three tranches and invest before 31 March.
HOW NOT TO INVEST IN ELSS
Avoid these mistakes that investors make.
INVESTING A LUMP SUM AT THE END OF THE YEAR
SIPs are by far the best way to invest in stocks and equity funds. Though SIPs in equity funds have seen a robust increase, the simple logic is lost on ELSS investors. AMFI data shows that nearly 50% of the total inflows into the ELSS category happen in the last three months of the financial year. The month of March alone accounts for 22-25% of the total inflows. Instead of taking the safer and more convenient SIP route, taxpayers get caught up in the year-end rush and invest a lump sum in risky assets.
BASING YOUR CHOICE ON SHORT-TERM PERFORMANCE
The other big mistake is to look at the shortterm performance of the funds and go with the best performer. ELSS funds are equity schemes, and the stability of the returns is more important than the quantum of gain.Look at the 3-year and 5-year performance of the scheme before you make a choice. We have identified the best ELSS schemes based on the Value Research star ratings, which take into account several parameters, including the stability of returns and long-term risk-adjusted performance.
CHOOSING THE WRONG OPTION
Dividends from mutual funds are just another way of booking profits. The dividend you receive gets deducted from the NAV, so you don't really gain anything. If you have invested in ELSS funds for the long term, don't go for the dividend option. The dividend reinvestment option is even worse. Every time the fund gives out a dividend and reinvests the money into your account, the three-year lock in period starts all over again. In effect, you are locked in for perpetuity.
IGNORING SMALLER FUNDS
With an annualised return of 13.84%, the Invesco India Tax Plan is the best performing ELSS fund in the past 10 years. But very few investors have gained from it, because its AUM is only `320 crore. The terrific returns generated by this tiny fund has led us to include this scheme in our list of top ELSS funds. So, don't base your choice on size but go by the performance.
REDEEMING AFTER LOCK-IN
Don't treat your ELSS funds as a short-term investment. There is a difference between lock-in and maturity. NSCs and tax-saving fixed deposits mature in five years and therefore the money comes back to you after five years. ELSS funds have a three-year lock in period, but this doesn't mean you should redeem the investment after three years.Look at ELSS funds as regular equity funds that should be held for the long term.
The NPS is a great way to save tax if you don't mind locking in your money till you retire. Till last year, the taxability of the NPS was a big issue. But last year's Budget changed the rules and made 40% of the corpus tax free. The PFRDA wants that the balance 60% to be exempt from tax as well. “The emphasis is on increasing pension coverage. So, allowing EEE status (to NPS) is our major demand (in the Budget),“ says PFRDA Chairman Hemant Contractor.
NPS is especially useful for investors who may have exhausted the `1.5 lakh investment limit under Section 80C but want to save more. Bangalore-based DINK couple Gauri and Sameer Bharwada (see picture) are aggressive savers and invest in mutual funds. They can cut their tax further if they put `50,000 each in NPS. Given their age, they should opt for the aggressive lifecycle fund that puts up to 75% in stocks. Another way the NPS can cut tax is by rejigging the salary.If a company deposits up to 10% of the basic salary of an employee in the NPS under Section 80CCD(2d), the amount will be tax free. Turn to page 28 to see how much tax this can save. However, the take-home pay of the employee will come down.
Many readers may not agree and even experts might have their reserva tions about them, but the new online Ulips are very different from the pre-2010 policies. The new Ulips have very low costs, which leaves a lot on the table for the buyer.According to Morningstar, aggressive Ulip plans have earned almost 12% annualised re turns in the past five years (see table). However, keep in mind that these numbers only indicate the rise in the NAV. Some Ulip charges are levied by cancelling units, so the actual returns for the investor are likely to be lower.Even so, the ease of online access has made these plans attractive and use friendly.
What's more, being insurance policies, the income from these plans is tax free under Section 10(10D). So, if you switch your corpus from debt to equity and then back to debt, the gains will not be taxed. You can also park short-term money in the liquid fund of your Ulip using the top-up facility.
Despite these advantages, Ulips continue to be in the doghouse. It is time for investors to assess these plans afresh, without being influenced by the chequered history of the category.
VPF AND PPF
The Provident Fund (PF) is the bulwark of the retirement savings of the aver age salaried employee. But it can also be a great way to save tax. Although an individual's contribution to the PF is linked to the salary, one can increase the amount by opting for the Voluntary Provident Fund (VPF). Contributions to the VPF are eligible for the same tax benefits as the PF. The best thing is that the money automatically flows into the PF account every month.
The interest rate on the PF has been cut by 15 basis points to 8.65% this year.Even so, it remains well above the average consumer inflation rate (5.3%). So the real rate of return for the investor is fairly attractive at over 3%.
For investors not covered by the PF, the Public Provident Fund (PPF) can be a suitable alternative. The interest rate is lower at 8%, but remains ahead of inflation. PSU bank employee Harshinder Kaur (see picture) is covered by the NPS. She uses the PPF for the remaining portion of her tax-saving investment limit under Sec 80C.
However, investors should be ready for rate cuts in the future. If the government had followed the Gopinath panel formula that links small savings interest rates with government bond yields, the PPF rate whould have been cut by almost 100 basis points to 7%. But analysts feel the government did not cut rates because it would have fuelled the simmering resentment against the demonetisation.
Even if the PPF rate is cut, it will give higher returns than bank deposits and corporate FDs. Banks have cut deposit rates to 7-7.5% and the interest is fully taxable. The post-tax return in the 30% tax bracket is barely 4.9-5.25%. “The tax-free PPF continues to be the best debt instrument for risk-averse investors,“ says Manoj Nagpal, CEO of Outlook Asia Capital.
SUKANYA SAMRIDDHI SCHEME
If you have a daughter below 10, the Sukanya Samriddhi Yojana (SSY) is a better alternative to the PPF. The SSY offers a higher interest rate of 8.5% and enjoys the same tax benefits as the PPF. But there are certain drawbacks, such as restrictions on withdrawals and a longer lock-in period.Like the PPF, the interest rate of the scheme might be cut in the future as interest rates come down. The government bond yield to which the scheme is linked is now hovering around 6.4%. Analysts believe the rates will eventually have to be aligned with the bond yields as per the formula suggested by the Gopinath panel.
Even so, the SSY is the best debt instrument for saving for your daughter's future requirements. Accounts can be opened at any post office or designated branches of PSU banks and select private banks with a minimum investment of `1,000. Every year, you must invest at least `1,000 in the account. There is also an investment limit of `1.5 lakh in a financial year. You can open accounts for up to two girls, but the combined limit cannot exceed `1.5 lakh.The account matures when the girl turns 21, though up to 50% of the corpus can be withdrawn after she is 18.
SENIOR CITIZENS' SAVING SCHEME
Senior citizen taxpayers have limited options because their risk profile is very different. The Senior Citizens' Savings Scheme is the best tax-saving option for them. It offers 8.5% returns and the interest is paid out every quarter. The payment dates are the same for all investors, irrespective of when they joined. It is a five-year scheme, and can be extended for a period of three years once it matures.
The account can be opened in any post office branch, designated branches of PSU banks and select private banks. However, there is an investment limit of `15 lakh per individual. Many retirees get around this restriction by gifting money to their spouses for investing in the scheme. Investors who have already hit that limit should look at other tax-saving options such as PPF and NSCs.Delhi-based finance professional Ranjit Rai Grover (see picture) puts `50,000 into the Senior Citizens' Saving Scheme and the balance `1 lakh in the PPF every year. “This is the safest tax-saving option for people in my age bracket,“ he says.
One good thing about the Senior Citizens' Saving Scheme is that it can be closed prematurely after one year, although there is a penalty to be paid for such foreclosure. If closed before two years, the investor has to pay 1.5% of the balance in the account. After two years, the penalty is lowered to 1% of the balance.
After spending several years in the doghouse, this popular tax-saving in strument is back in the limelight.While banks have cut interest rates on taxsaving FDs, small savings schemes (inclduing NSCs) have been spared. At 8%, the five-year NSCs are offering close to 75-100 basis points more than what fixed deposits give. Also, unlike PPF and SSY, the interest rate of the NSC does not change if rates are cut. What's more, the interest earned on the NSC is also eligible for deduction under Section 80C in the following years. “The tax benefit on the interest effectively makes it tax free for investors who may not have hit the annual ceiling of `1.5 lakh under Section 80C,“ says investment and tax expert Balwant Jain.
This is probably the easiest way to save tax if you have a Netbanking account.
After the demonetisation and the digital push, almost everyone has one. A few clicks of the mouse and your tax planning is done. However, as mentioned earlier, this convenience comes at a very high cost. Interest rates have come down significantly and are close to 7-7.5% right now. The bigger problem is that the interest is fully taxable. It is added to the income of the investor and taxed at the marginal rate applicable to him.In the highest 30% tax bracket, the post-tax yield is close to 5%.
Even so, tax-saving fixed deposits are suitable for risk averse investors, especially senior citizens who might already have hit the `15 lakh ceiling in the Senior Citizens' Saving Scheme and don't want to lock in money for the long term in a PPF account. Though NSCs offer higher rates than most banks, many senior citizens prefer to invest in deposits of their own banks, because they get better service than in a post office. Familiarity with bank staff is another important factor. These deposits are also useful when time is running out and the taxpayer is unable to decide where to invest, since they can be opened very quickly.
However, keep in mind that the interest from such deposits will be subject to TDS if the total income exceeds `10,000 in a financial year. Many investors have the misconception that if TDS has been paid, they have no further tax liability. This not correct. The TDS rate is only 10% and they have to pay additional tax if they fall in the 20% or 30% tax brackets.
It doesn't stop here. Taxpayers will also have to report the income in their tax returns as income from other sources. Ignore reporting the income at your own peril. When TDS is cut, it gets reflected in the Form 26AS of the individual. The information in the Form 26AS is matched with the returns filed by the taxpayer. If tax has been cut, but that income is not declared by the taxpayer, he will surely get a notice for the discrepancy.
Pension plans from insurance companies are not a great way to save tax be cause of the high charges. Although Ulip charges have been reduced, pension plans still levy high charges on buyers. In comparison, the low-cost NPS is a much better alternative. The pension plans from insurance companies are also not as tax friendly. Only 33% of the corpus can be withdrawn at the time of maturity and is tax free. The balance 66% has to be compulsorily put in an annuity to get a monthly pension that is fully taxable. For the NPS, up to 40% of the corpus is tax free. Of the balance amount, only 40% has to be put in an annuity.
Every year, millions of Indians buy life insurance policies to save tax. These policies neither give good returns, nor offer adequate cover to the policyholder.They eventually become millstones around the necks of the buyers, preventing them from investing for other financial goals.Pune-based Vinayak Srigadi (see picture) pays `97,000 for three endowment policies.“I plan to surrender them this year. I will suffer a loss of around `1 lakh if I do that,“ he says. But Srigadi knows that he will suffer a bigger loss if he continues to pour money into these low-yield policies.