Before you decide to invest in a tax-saving instrument, go through this guide and rating of the most widely used options under Section 80C.
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 rated the most common investments under Section 80C on five basic parameters: returns, safety, flexibility, liquidity and taxability. The rating separates the chaff from the grain. Whether you are a novice or a seasoned investor, 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)
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.
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.
Invest before the 5th of the month if you want your contribution to earn interest for that month as well.
RETURNS: 17.5% (Past five years)
Equity-linked saving schemes (ELSS) are at second place in our ranking. These funds can generate good returns for investors over the long term. In the past five years, this category has given average returns of 17.5%.
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. Even the best performing funds have churned out disappointing returns in the past three years. 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.
Though the ELSS funds invest in equities, they are different from other open-ended 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.
ELSS funds offer tremendous flexibility to investors. 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.
The minimum investment is also very low. 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.
ULIPs and NPS
RETURNS: 4.2-11.8% (Past 3 years)
For many policyholders, Ulips denote the costly mistake they made a few years ago. But 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.
We checked Morningstar's data on Ulips and found that the returns have not been very good in the past 5 years. But a Ulip is not necessarily an equity-linked investment. You can also invest your Ulip corpus in debt funds. 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.
Like the Ulips, the 3-year returns from the NPS funds are also a mixed bag. While the 4.15% average returns from the E class (equity) funds are in line with the market returns, the 6.62% from the G class (gilt) funds are quite a disappointment. The redeeming feature is the 10.24% returns churned out by the C class (corporate bond) funds.
Its low-cost structure, flexibility and other investor-friendly features make the NPS 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.
One of the most outstanding features of the NPS is the 'lifecycle fund'. 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%.
Opt for the liquid or debt fund and then shift to the equity option as per your reading of the market.
NSCs AND BANK FDs
RETURNS: 8.5-10% (for 2013-14)
Many taxpayers think that up to 10,000 interest from bank deposits is tax-free, as announced in the budget two years ago. But the newly introduced Section 80TTA gives a deduction of up to 10,000 on interest earned in the savings bank account, not on FDs 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. So don't get misled by the high interest rates offered on the 5-year bank fixed deposits. The post-tax 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. 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.
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
Though the Irda guidelines for traditional plans have made insurance policies more customerfriendly 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 plans 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 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.