The Gravy Train Has Left the Station

Save yourself the last-minute scramble. There isn’t much joy left in tax-saving investments.

Save yourself the last-minute scramble. There isn’t much joy left in tax-saving investments.

It’s one of those things we do on autopilot, a conditioned reflex that has outlived its relevance. Every year around this time, we make a desperate dash to make some tax-saving investments. Typically it’s our employers who call ‘time’, and demand that we submit proof of our tax-saving investments by x date, or else… The ‘or else’ is far less threatening than we fear, and with great relief we part with our money to ‘invest’ in anything that will save us paying more tax. Because saving tax becomes an end in itself, we end up committing our money to schemes that are not necessarily best for us. How do we avoid this? Well, for a start, stay awake for the length of this piece.

The total amount of eligible investment for tax-saving is only Rs 1 lakh, on which you save at the tax rate applicable to your level of income. In the highest slab of income, you’re liable to pay 30.90 per cent tax; the maximum tax saving is, therefore, Rs 30,900.

Most of us already have some regular payments or investments that qualify for this benefit, such as children’s school or college fees, provident fund contributions deducted from our salary, premiums on existing life insurance policies and repayment of housing loans. It is only when the total amount of such payments/investments is less than Rs 1 lakh that additional investments (in schemes that qualify for the same benefit) bring us additional tax relief or allow us to claim the maximum permissible tax deduction.

So, the first thing about making tax-saving investments is to see if you’ve already exhausted the eligible limit of tax deduction. If you haven’t and you still need to invest to max your tax benefits, consider the following to arrive at a shortlist of the best options for you:

Tax bracket. If you’re in the highest tax bracket, remember that income on some investments is taxable, which will lower your net return. You may, therefore, prefer investments that yield tax-free returns.

Liquidity. If you’re likely to draw on these investments in the short term, look at shorter-term investments or investments that give regular returns, rather than those where your money is locked in till maturity.

Safety. A younger taxpayer may prefer a higher-risk investment that yields higher returns, such as equity-linked products, while an older taxpayer may prefer a safe investment with lower returns.

Portfolio. To a certain extent, your choice will also depend on the composition of your existing investment portfolio. If you already have high exposure to equities, you may prefer a debt product to balance your portfolio.

Bear these factors in mind when you decide which tax-saving vehicle to ride. They come in a myriad shapes, but some are better than others. A quick review:

The premiums you pay on life insurance policies do qualify for the benefit, but life policies are not really meant to be investments; they are best used as pure insurance. So, consider low-cost term policies for your insurance needs, and channel the ‘savings’ in premium into tax-saving investments that deliver better returns. ULIPs (unit-linked insurance plans), for example, which offer the twin benefits of insurance and investment, are best avoided because they typically yield lower returns than a pure equity product.

Likewise, other hybrid products like endowment policies and moneyback plans yield a far lower rate of return than alternative investments because the ‘bonus’ on these policies is computed on a simple interest basis and not compounded annually or half-yearly as in the case of other investments. Bottomline: use insurance policies purely as insurance (read: pure term policies only), not as tax-savers. That end is better served by:

For one, Public Provident Fund (PPF), which you should certainly consider if you’re looking for safe returns from a debt product. It fetches 8 per cent tax-free returns, which is 11.58 per cent before tax for people in the highest tax bracket. Given the high rate of return and the absolute safety (it’s guaranteed by the government), PPF investments make sense even if you have exhausted your tax benefits because of the Rs 1 lakh limit. You’re allowed to deposit upto Rs 70,000 a year in your PPF account. It’s a 15-year scheme, after which you can renew it in blocks of five years. Withdrawals are allowed after five years, subject to a maximum of one withdrawal per year; the amount you can draw depends on the balance in your account three years before the date of withdrawal. One of the arguments against PPF is its supposed illiquidity, but it isn’t really after the initial five years.

National Saving Certificates (NSC) too fetch 8 per cent compounded half-yearly, but their appeal has waned because: i) the returns are fully taxable; and ii) you get both interest and principal only on maturity at the end of six years. The advantage, however, is that the interest that accrues on earlier investments is deemed to have been reinvested every year and, therefore, qualifies for the benefit of deduction in subsequent years. So, although the interest income from NSC is clubbed with your taxable income, the income (because it’s deemed reinvested) also qualifies for the benefit of deduction as an investment, effectively nullifying the tax on interest.

The equity-linked saving schemes (ELSS) of mutual funds are a good investment avenue for young taxpayers. The returns from these are linked to the unpredictable fate of the stock markets, hence the age caveat. Returns from these schemes have been handsome for those who invested when the markets were down—for example, if you’d invested in January to March 2009, when the stock markets were touching new lows, you may have earned as much as 80-100 per cent in less than a year.

There is a three-year lock-in with these schemes (you can’t sell for three years), but you don’t have to sell after three years. Sell when the market is at a high. Given that the stock markets are currently at fairly high levels, equity-linked schemes don’t look so tempting. Look to invest in these schemes when the stock market slides again. Your income from ELSS investments is tax-exempt, because the mutual fund is liable to pay an income-distribution tax. Even the capital gains you make on redemption of units are tax-exempt.

The National Pension Scheme, introduced in May 2009, is another option. It allows you to opt for private sector investment managers and has plans that offer a mix of debt and equity. However, it is a long-term vehicle, and withdrawals from the account are fully taxable, except when it is to buy an annuity. Also, the regular annuity you receive is taxable. The quantum of eligible investment in NPS is capped at 10 per cent of your salary or 10 per cent of gross total income, whichever is applicable.

Senior citizens above the age of 60 have the option of investing in the Senior Citizens Savings Scheme, which gives a quarterly taxable interest of 9 per cent per annum. This investment is for a period of six years, but offers high safety and regular returns. This will appeal to those seeking liquidity, and those who are not in the highest tax bracket of 30.90 per cent.

Risk-averse taxpayers in the lower tax brackets can consider the five-year tax-saving term deposits with banks. The interest rates on these deposits vary from bank to bank. Interest on these deposits is fully taxable, which makes them unattractive for taxpayers in the highest tax bracket.

That’s about it. Chances are you’ll have found something here that suits your needs. If not, and especially if you are not in the highest tax bracket, you can certainly consider not claiming the full deduction of Rs 1 lakh, pay the tax, and have the balance amount free to invest in avenues more to your liking. Happy investing!

The author is Partner at Contractor, Nayak and Kishnadwala Chartered Accountants, based in Mumbai.

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