An analysis of the tax-saving options available under S ection 80C:
Public Provident Fund
Invest in this old favourite before the tax laws change.
Tax exemption on the amount invested, tax free interest and even withdrawals. For those who don’t believe in living on the edge, tax planning doesn’t get better than this. The happy times may not last long though. With the proposed phasing out of EEE (exemptexempt-exempt, where investments, income and withdrawals are not taxed) regime, interest earned on PPF deposits may be taxed at the time of withdrawal.
But this is likely to be with prospective effect, leaving existing investments out of the tax net (see guest column: EETing Into Your Returns). PPF also scores on the tax front. Section 80L, under which up to Rs 12,000 of interest income (from bank deposits and other specified securities, including NSCs) in a year was tax free, has been removed.
In the 30% tax bracket (income above Rs 2.5 lakh a year), investments in these instruments will yield a post-tax return of 5.6%. Bharat Bhushan, CEO of Noidabased financial planning firm Money Options, says there has been a surge in PPF deposits after the removal of Section 80L. Investors are scrambling for the tax benefits. But you can invest only Rs 70,000 in PPF in a financial year (see story on page 52). Join the party before the taxman realises he is giving too much away.
NSCs and Bank FDs
If the income they earn is taxed, what makes NSCs still hot? Safety, liquidity and 8% assured returns. But as your income levels rise, they become increasingly tepid. For instance, if you fall in the highest tax bracket, NSC investment notwithstanding, you will be paying 30% tax on the income plus surcharge. Even in the 20% bracket (annual taxable income between Rs 1.5 lakh and Rs 2.5 lakh), the post-tax yield is less than 6.5%.
FIVE-YEAR FD RATES (%) |
| Kotak Bank 8.25 |
| UCO Bank 8.25 |
| Tamil Mercantile Bank 8.50 |
| Saraswat Bank 8.50 |
| Cosmos Co-op Bank 8.50 |
| Shamrao Vithal Co-op Bank 9.00 |
Keep in mind though that NSCs are government bonds, and therefore offer the highest safety. It is here that fixed deposits lose out. Of course, it is fairly safe to invest in a nationalised bank or even a good private bank. But steer clear of the attractive rates being offered by little known banks. What’s a devil if he is not tempting?
Insurance policies
When you ask your money to run a race for big returns, don’t expect it to scramble back when you feel a sudden need. Then your money gets confused and can do neither well. So keep investment and insurance separate.
Unsuitably insured |
| Option Returns (%) |
| Money-back policies 4-5 |
| Endowment policies 5-6 |
| NSC and FDs 8-9 |
| PPF/EPF 8-8.50 |
| ELSS 15-20 |
Your insurance agent may argue that you need to factor in the life cover offered by an endowment policy when evaluating its value. But the cover too is abysmally low. For instance, a 40-year-old man will pay around Rs 41,000 every year for 15 years to get a cover of Rs 5 lakh.
If you have made the mistake, is there a way out? Yes, you can convert your existing endowment policy into a paid-up policy. As far as insurance is concerned,buy a term plan that gives you life cover without charging a huge premium. If the 40-year-old did not buy an endowment plan and instead took a term plan, a Rs 5 lakh cover for 15 years would cost him less than Rs 3,000. That leaves him with a surplus of Rs 38,000 which could be investedin other avenues for higher returns. Why, even PPF will give him higher returns than his endowment policy.
Of course, you must keep one thing in mind: term plans are pure insurance products and the policyholder does not get anything back at the end of the policy term. The premium paid goes into buying the life cover, much like in the case of your medical or car insurance.
WHY YOU ARE A TAX EVADER Are you a tax evader? You probably are. The removal of Section 80L, under which Rs 12,000 of interest income (from bank deposits and specified government securities) in a year was tax free, has turned thousands of honest taxpayers like you and me into tax evaders. If you have some money in a bank account—savings, recurring, sweep-in or current—you must have earned some interest on that in the past year. And if you have not included that interest in your income for the year, you are evading taxes. This is not a hypothetical scenario. It is not uncommon for people to have savings bank accounts they haven’t operated for years. In some cases, the account holders don’t even know that these bank accounts exist. Many of these bank accounts were opened when the account holders were minors. When they took up jobs they opened new accounts but didn’t close the old ones. Interest income from the small balances in these dormant accounts must be included in the income for the year and is liable to tax at normal rates. Relocation to another city is another reason why people have multiple bank accounts. It is easy to open a fresh account than get an existing one transferred to the new city. Perhaps the finance minister should revisit the decision to abolish Section 80L so that thousands of innocent tax evaders can become honest once again. |
Unit-Linked Insurance Plans
A high-cost mutual fund that also gives you a small life cover
We just said that insurance cum investment is not a very good idea. But in the past few years, insurance companies have carpet-bombed the market with unit-linked insurance plans (ULIPs). Investors in ULIPs can choose to allocate their money in a mix of stocks and debt instruments. Those who went for a 100% equity allocation a couple of years ago are lucky that their entry coincided with the longest bull run in the history of Indian stock markets. Otherwise, ULIPs are not a very good investment option. For one, the high charges in the initial years eat into your returns.
ULIPS |
| Up to 30% of premium goes into charges in initial years. |
| Investors can change from equity to debt and vice versa. |
| The profit from switching is tax free because it is an insurance plan. |
This is not possible in a tax plan from a mutual fund where the investment is locked in for three years. But Bhushan points out that such switching amounts to trying to time the market. “If somebody is so sure about the future movement of the markets, he should be a fund manager, not a small investor,” he says.
Pension policies
Wait till retirement and pray that interest rates don’t fall
With the removal of sub-limits pension policies of insurance companies also ceased to be in the good books of intelligent tax planners. Before the introduction of Section 80C, investments of up to Rs 10,000 a year in pension products got exemption under Section 80CCC. For people in the highest tax bracket, that was a great way of saving tax. These good times continued only till last year.
PENSION POLICIES |
| Investor gets up to 25% of the corpus on retirement. |
| Remaining is invested and earns an monthly income. |
| If interest rate is 3%, a corpus of Rs 1 crore will earn Rs 25,000 a month. |
Now, the premium paid for a pension policy is part of the Rs 1 lakh limit under Section 80C. You can even invest the entire Rs 1 lakh in a pension plan. Only, that would not be a very good idea. Here’s why. Pension funds are invested in ultra-safe avenues like government bonds which give ultra-low returns. If the prevailing interest rate is about 3-4%, a corpus of Rs 1 crore will give the pensioner a monthly income of Rs 25,000-33,000. Moreover, the Indian economy is on the growth track. In about 20-25 years, India could be a developed economy. In mature markets, interest rates are very low compared to developing countries.
The 10-year bond rate in Japan is 1.62% and in the US is 4.57% compared with 7.63% in India. In about 20-25 years, this benchmark interest rate might drop to about 4-5%. Pension plans are meant for retirement earning. Sadly, with them your money might dwindle than gain in value, just when you needed it most.
However one interesting option which can be considered is mutual fund-based retirement plans. These funds have a low equity component. This helps boosts returns when the markets are booming but lends stability through a volatile phase. But consider this option only if the holding period is not a concern. They mature when the investor turns 58. Withdrawals before that invite a high exit load of up to 3%.
STUDIED RETURNS Do you shy away from filing tax returns only because you fear the hassles? Okay, maybe you don’t understand some part of it too. Help is at hand. The Department of Income Tax has launched a Certified Tax Return Preparer programme which will train graduates to help people with taxable income up to Rs 3 lakh file their income tax returns. The programme which will be conducted across NIIT centres in 84 cities is an annual affair. The entrance exam is structured on the line of management entrance tests like MAT. It follows a three-tier structure starting with a 15-day self-study schedule on tax laws and filing processes followed by a nine-day stint at NIIT to brush up computer skills. NIIT will then run a website incorporating different case studies and assignments. After nine months, trainees take an online test. Once certified, tax return preparers will be allotted a unique identification number which will enable them to file returns for individuals with a taxable income of up to Rs 3 lakh a year. They will receive 3% of the tax paid on the returns prepared and filed for every new assessee in the first year (subject to a maximum of Rs 1,000), 2% in the second year and 1% in the third year. And how much would it cost existing assessees: just Rs 250 for preparing and filing returns. As the first batch starts training this January, only time will tell how untaxing this initiative is. —TANMOY NEOG |
ELSS Mutual Funds
Fantastic returns in past five years. But don’t expect an encore.
Sure they provoke suicidal tendencies from time to time. But playing in the stock markets was never for the weak. And of course, the risks have rich, very rich gains. For long-term wealth creation, there is nothing to beat equities. The longer the holding period, the higher the returns. Data for the past 26 years shows that if somebody bought Sensex shares and held them for at least five years, he would have got an annualised return of over 30%.
With equity-linked savings schemes (ELSS) there are tax benefits under Section 80 C that adds to the magic. There is no tax on long term capital gains from equitybased mutual funds if the holding period is over a year. ELSS funds have a three-year lock-in period, so they fulfill the criteria. Even the dividends are tax free, since these are equity-based funds. Says Mumbaibased financial planner and director of Transcend Consulting, Kartik Jhaveri: “ELSS is one of the best ways of investing in equities.” The freeing up of Section 88 sub-limits means that the entire Rs 1 lakh can be put in ELSS.
TOP ELSS PERFORMERS |
| Fund Returns (%) |
| Magnum Taxgain 63.72 |
| HDFC Taxsaver 51.62 |
| Sundaram BNP Tax 44.35 |
| Pru ICICI Tax Plan 42.80 |
| HDFC LT Advantage 41.13 |
| Three-year annualised returns as on 3 January |
Is it prudent to invest in stocks when the Sensex is at an all time high? It’s really a question of your investment horizon and risk capacity. The returns are certainly higher but so are the risks. Enter only if you can take a 25-30% hit if markets crash. The younger you are, the better you are placed to tide over the ups and downs of the market. As the May 2006 crash illustrated, the markets are on solid ground as far as fundamentals are concerned.
The price-to-earnings (PE) ratio of a company is a good barometer of its valuation. A low PE means the share is undervalued; a high PE means it is overvalued. Before the 2000 crash, when the NIfty was at 1818 points, the average PE of 50 Nifty shares was 27.3. Right now, with the Nifty close to 4000, the average PE is 21.38. Jhaveri advises investors to invest in ELSS funds with a 5-10 year perspective for maximum gains.
—with KAMYA JAISWAL
