FINANCE
TAX SPECIAL BEST WAYS TO SAVE TAX PART 1
Select
from the following options to manage your tax savings in a better way.
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.
PUBLIC PROVIDENT FUND RETURNS: 8.7%
(for 2013-14)
This all-time favourite became even more attractive after the interest rate was linked to bond yields in the secondary market.
The PPF is our top choice as a tax saver in 2014. It scores well on almost all parameters. This small saving scheme has always been a favourite tax-saving tool, but the linking of its interest rate to the bond yield in the secondary market has made it even better. This ensures that the PPF returns are in line with the prevailing market rates.
This year, the PPF will earn 8.7%, 25 basis points above the average benchmark yield in the previous fiscal year. The benchmark yield had shot up in July and has mostly remained above 8.5% in the past six months. Although the yield is unlikely to sustain at the current levels, analysts don’t expect it to fall below 8.25% within the next 2-3 months. So it is reasonable to expect that the PPF rate would be hiked marginally in 2014-15.
The PPF offers investors a lot of flexibility. You can open an account in a post office branch or a bank. However, the commission payable to an agent for opening this account has been discontinued, so you will have to manage the paperwork yourself. The good news is that some private banks, such as ICICI Bank, allow online investments in the PPF accounts with them.
There’s flexibility even in the quantum and periodicity of investment. The maximum investment of `1 lakh in a year can be done as a lump sum or as instalments on any working day of the year. Just make sure you invest the minimum `500 in your PPF account in a year, otherwise you will be slapped with a nominal, but irksome, penalty of `50. Though the PPF account matures in 15 years, you can extend it in blocks of five years each. However, this facility is no longer available to HUFs.
The PPF also offers liquidity to the investor. If you need money, you can withdraw after the fifth year, but withdrawals cannot exceed 50% of the balance at the end of the fourth year, or the immediate preceding year, whichever is lower. Also, only one withdrawal is allowed in a financial year. You can also take a loan against the PPF, but it cannot exceed 25% of the balance in the preceding year. The loan is charged at 2% till 36 months, and 6% for longer tenures. Till a loan is repaid, you can’t take more.
If you dip into your PPF account, be sure to put back the amount at the earliest. Withdrawing from long-term savings is not a good strategy if you do it frequently. It can dent your overall retirement planning.
The PPF is especially useful for riskaverse investors, self-employed professionals and those not covered by the Employees Provident Fund and other retiral benefits.
BRIGHT IDEA
Invest before the 5th of the month if you want your contribution to earn interest for that
month as well.
This all-time favourite became even more attractive after the interest rate was linked to bond yields in the secondary market.
The PPF is our top choice as a tax saver in 2014. It scores well on almost all parameters. This small saving scheme has always been a favourite tax-saving tool, but the linking of its interest rate to the bond yield in the secondary market has made it even better. This ensures that the PPF returns are in line with the prevailing market rates.
This year, the PPF will earn 8.7%, 25 basis points above the average benchmark yield in the previous fiscal year. The benchmark yield had shot up in July and has mostly remained above 8.5% in the past six months. Although the yield is unlikely to sustain at the current levels, analysts don’t expect it to fall below 8.25% within the next 2-3 months. So it is reasonable to expect that the PPF rate would be hiked marginally in 2014-15.
The PPF offers investors a lot of flexibility. You can open an account in a post office branch or a bank. However, the commission payable to an agent for opening this account has been discontinued, so you will have to manage the paperwork yourself. The good news is that some private banks, such as ICICI Bank, allow online investments in the PPF accounts with them.
There’s flexibility even in the quantum and periodicity of investment. The maximum investment of `1 lakh in a year can be done as a lump sum or as instalments on any working day of the year. Just make sure you invest the minimum `500 in your PPF account in a year, otherwise you will be slapped with a nominal, but irksome, penalty of `50. Though the PPF account matures in 15 years, you can extend it in blocks of five years each. However, this facility is no longer available to HUFs.
The PPF also offers liquidity to the investor. If you need money, you can withdraw after the fifth year, but withdrawals cannot exceed 50% of the balance at the end of the fourth year, or the immediate preceding year, whichever is lower. Also, only one withdrawal is allowed in a financial year. You can also take a loan against the PPF, but it cannot exceed 25% of the balance in the preceding year. The loan is charged at 2% till 36 months, and 6% for longer tenures. Till a loan is repaid, you can’t take more.
If you dip into your PPF account, be sure to put back the amount at the earliest. Withdrawing from long-term savings is not a good strategy if you do it frequently. It can dent your overall retirement planning.
The PPF is especially useful for riskaverse investors, self-employed professionals and those not covered by the Employees Provident Fund and other retiral benefits.
BRIGHT IDEA
Invest before the 5th of the month if you want your contribution to earn interest for that
month as well.
ELSS FUNDS RETURNS: 17.5% (Past five
years)
The potential for high returns, wide choice of funds and flexibility make these funds a good tax-saving option for equity investors.
Equity-linked saving schemes (ELSS) have the shortest lock-in period of three years among all the tax-saving options under Section 80C. However, this should not be the most important reason for investing in this avenue. Being equity funds, these schemes can generate good returns for investors over the long term. In the past five years, this category has created wealth for investors with average returns of 17.5% (see table).
However, this potential to earn high returns comes with a higher risk. There is no guarantee that your investment will generate positive returns after the 3-year lock-in period. The category has generated an average return of 2% in the past three years. Even the best performing funds have churned out disappointing returns. The returns will naturally mirror the performance of the stock markets. Therefore, only investors who have the stomach for a roller-coaster ride should consider this option.
Should investors avoid ELSS now, especially since the stock market is close to its all-time high? Not really, because the stock market has returned to the previous high after a 6-year gap and, therefore, is not overvalued at all. “Since the stock market is reasonably valued now, ELSS should generate good returns for investors who can remain invested for 5-7 years,” says Gajendra Kothari, managing director and CEO, Etica Wealth Management. Though the large-cap Sensex and Nifty are at higher levels, the mid-cap and small-cap indices are at much lower levels. This means there is enough value in midcap stocks, which should help the fund managers do well in the coming years.
Selecting the right scheme is crucial since there is significant variation in the returns of different schemes (see table). Though past performance is an important parameter, also take into account the track record of the fund house and fund manager.
Once you select a scheme, decide whether you want to go for the dividend or growth option. There is no difference in the tax treatment of the two options. The decision should be based on the cash-flow requirements of the investor. If you opt for the dividend option of the fund, you might get some portion of the money back within 1-2 months. Dividends from mutual funds are tax-free so there is no tax liability as well.
Avoid the dividend reinvestment option for ELSS schemes because the lock-in period will prevent you from exiting fully.
Though the ELSS funds invest in equities, they are different from other openended diversified equity funds. Due to the lock-in period, the ELSS fund manager does not have to worry about redemption pressure from investors. This gives him the freedom to invest in shares as per his conviction and hold them for longer periods. In the past few years, the ELSS category has consistently outperformed the large and midcap sub-category of diversified equity funds (see graphic).
ELSS funds offer tremendous flexibility to investors. As mentioned earlier, the 3-year lock-in period is the shortest. Since there is no tax on gains from equity funds after a year, an investor can safely recycle his investments every three years and claim tax benefits on the reinvested amount. Young taxpayers, who have taken huge loans and don’t have enough surplus to save tax, will find these schemes very useful. If you can help it, don’t exit the scheme after three years just because lock-in period is over. Studies show that equities give better returns in the long term.
The minimum investment is also very low. Though regular equity mutual funds have a minimum investment of 5,000, you can put in as little as `500 in an ELSS scheme. Unlike a Ulip, pension plan or an insurance policy, there is no compulsion to continue investments in subsequent years.
Since ELSS funds are a high-risk investment and their NAVs are volatile, you need to stagger your investment over a period of time instead of going for a lump-sum investment at the end of the financial year. This is more important at this juncture when the benchmark indices are trading close to their all-time high levels. Your best option is to take the SIP route. This may not be possible now because you have less than three months before the 31 March deadline. At best, you can split the investment into three tranches.
Before you take the plunge, remember that your investment should be guided by your overall asset allocation. If your exposure to equities is lower than what you want, go for the ELSS fund. If your portfolio already has too much equity, avoid investing in these funds.
BRIGHT IDEA
Don’t invest a lump sum. Split investments in ELSS funds into three SIPs starting from January till March.
The potential for high returns, wide choice of funds and flexibility make these funds a good tax-saving option for equity investors.
Equity-linked saving schemes (ELSS) have the shortest lock-in period of three years among all the tax-saving options under Section 80C. However, this should not be the most important reason for investing in this avenue. Being equity funds, these schemes can generate good returns for investors over the long term. In the past five years, this category has created wealth for investors with average returns of 17.5% (see table).
However, this potential to earn high returns comes with a higher risk. There is no guarantee that your investment will generate positive returns after the 3-year lock-in period. The category has generated an average return of 2% in the past three years. Even the best performing funds have churned out disappointing returns. The returns will naturally mirror the performance of the stock markets. Therefore, only investors who have the stomach for a roller-coaster ride should consider this option.
Should investors avoid ELSS now, especially since the stock market is close to its all-time high? Not really, because the stock market has returned to the previous high after a 6-year gap and, therefore, is not overvalued at all. “Since the stock market is reasonably valued now, ELSS should generate good returns for investors who can remain invested for 5-7 years,” says Gajendra Kothari, managing director and CEO, Etica Wealth Management. Though the large-cap Sensex and Nifty are at higher levels, the mid-cap and small-cap indices are at much lower levels. This means there is enough value in midcap stocks, which should help the fund managers do well in the coming years.
Selecting the right scheme is crucial since there is significant variation in the returns of different schemes (see table). Though past performance is an important parameter, also take into account the track record of the fund house and fund manager.
Once you select a scheme, decide whether you want to go for the dividend or growth option. There is no difference in the tax treatment of the two options. The decision should be based on the cash-flow requirements of the investor. If you opt for the dividend option of the fund, you might get some portion of the money back within 1-2 months. Dividends from mutual funds are tax-free so there is no tax liability as well.
Avoid the dividend reinvestment option for ELSS schemes because the lock-in period will prevent you from exiting fully.
Though the ELSS funds invest in equities, they are different from other openended diversified equity funds. Due to the lock-in period, the ELSS fund manager does not have to worry about redemption pressure from investors. This gives him the freedom to invest in shares as per his conviction and hold them for longer periods. In the past few years, the ELSS category has consistently outperformed the large and midcap sub-category of diversified equity funds (see graphic).
ELSS funds offer tremendous flexibility to investors. As mentioned earlier, the 3-year lock-in period is the shortest. Since there is no tax on gains from equity funds after a year, an investor can safely recycle his investments every three years and claim tax benefits on the reinvested amount. Young taxpayers, who have taken huge loans and don’t have enough surplus to save tax, will find these schemes very useful. If you can help it, don’t exit the scheme after three years just because lock-in period is over. Studies show that equities give better returns in the long term.
The minimum investment is also very low. Though regular equity mutual funds have a minimum investment of 5,000, you can put in as little as `500 in an ELSS scheme. Unlike a Ulip, pension plan or an insurance policy, there is no compulsion to continue investments in subsequent years.
Since ELSS funds are a high-risk investment and their NAVs are volatile, you need to stagger your investment over a period of time instead of going for a lump-sum investment at the end of the financial year. This is more important at this juncture when the benchmark indices are trading close to their all-time high levels. Your best option is to take the SIP route. This may not be possible now because you have less than three months before the 31 March deadline. At best, you can split the investment into three tranches.
Before you take the plunge, remember that your investment should be guided by your overall asset allocation. If your exposure to equities is lower than what you want, go for the ELSS fund. If your portfolio already has too much equity, avoid investing in these funds.
BRIGHT IDEA
Don’t invest a lump sum. Split investments in ELSS funds into three SIPs starting from January till March.
ULIPs RETURNS: 7.2-11.8% (Past five
years) Don’t go by the past record. The new Ulip is a good way to invest in the equity and debt markets for tax-free returns.
There’s a good reason why this most hated investment is so high on our rating scale. For many policyholders, Ulips denote the costly mistake they made a few years ago. But that was a different era, when companies were gobbling up 50-60% of the premium in the first few years in the guise of charges. The 2010 guidelines have reformed the Ulip, turning it into a more customer-friendly investment. Though a Ulip should not be your first insurance policy, you can consider buying one as an investment that also helps you save tax. Of course, it also offers a life cover, but the stress is on investment, not protection.
Don’t buy a Ulip (or any other insurance policy, for that matter) if you are not sure whether you can continue paying the premium for the entire term. If you end it prematurely, be ready to pay surrender charges. Your insurance policy should not impinge on other financial commitments. It’s easy to set aside a big sum when you are young because your liabilities are limited, but this changes and expenses shoot up when you start a family or buy assets. If the premium is very high, the policyholder may find it difficult to pay it year after year. Under the new Ulip rules, you cannot take a premium holiday. If you stop paying the premium, the policy will be discontinued.
Also, you need to take a long-term view when you buy an insurance plan. A Ulip will yield good results only if you hold it for at least 10-12 years. Before that, the plan may not be able to recover the charges levied in the first few years. This is why short-term plans of 5-10 years usually give poor results, which pushes investors to dump them within 3-4 years of buying.
Buyers must also understand that a Ulip is not necessarily an equity-linked investment. You can also invest your Ulip corpus in debt funds. Right now, debt funds are looking attractive because of the possibility of a drop in bond yields, while the equity markets are looking overheated. Instead of investing in the equity option, put your corpus in the debt fund. You can start shifting the money to the equity fund when the prospects look rosier. Only a Ulip allows you to switch from debt to equity, or vice versa, without incurring any capital gains tax.
It is best to invest in a plain vanilla Ulip that allows you to choose your investment mix and also offers online transaction facilities.
BRIGHT IDEA
Opt for the liquid or debt fund and then shift to the equity option as per your reading of the market.
continues in PART 2
ETW140106
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