Incremental Gains

Chandralekha Mukerji | Print Edition: June 2012

If you have got a pay rise this year, you are among the privileged lot. The economy is weak and average increments have been a mere 8.5-10 per cent. In fact, there is news of employees getting pink slips in distressed sectors such as aviation and telecom.

This means you must make all the more effort to make the best possible use of this additional cash flow. This does not involve just buying a product that will fetch you high returns. The investment must gel with your overall plan and, if possible, get you a tax rebate as well.

"Most people start looking for investment avenues in February-March, that is, just before the financial year closes, and buy just any tax-saving instrument without considering if it supports their overall financial plan or not," says Rahul Rege, business head, retail, Emkay Global Financial Services.

ALL YOU NEED TO KNOW: About investing right

Keeping surplus money in a savings account and investing at the end of the year means you lose a year's interest. It is, therefore, wise to channelise this additional income systematically from the beginning of the year.

Ad-hoc investing will only complicate your finances and not get you anywhere. It is necessary that you first analyse your situation and take steps accordingly.

Whether you should increase your debt re-payments or not will entirely depend on the kind of debt you hold and its cost. "A home loan or an education loan need not be paid upfront as, one, an individual gets tax rebate on these and, two, their interest rates are only marginally higher than the return that can be generated by investing the available corpus," says Soumya Acharya, regional business head, North, Fullerton Securities and Wealth Advisors.

If you have high-cost debt, for instance credit card dues, whose interest rate is higher than the best return you can earn, it is wise to clear the debt first.

"Pay your credit card dues (on which you pay 40-45 per cent interest a year), any personal loan (rate upwards of 20 per cent) or even a home loan (if floating rates have risen to 13-15 per cent). The interest rates on these forms of debt are very high," says Manish Jain a Gurgaon-based Certified Financial Planner.

Pay increase (per cent)
There are a lot of options to invest Rs 1 lakh to save tax under Section 80C of the Income Tax Act, 1961.

Equity-linked savings schemes, or ELSS, can be a good way to invest every month for saving tax and getting good returns. Under ELSS, one does not have to give an annual commitment as the investment amount from one year to another can be different. There is a three-year lock-in and returns are tax-free.

On the other hand, interest rates are near peak and there is no sign of their falling in the near term as inflation has again crossed the 8 per cent mark. Even the rupee is weakening against the US dollar, which will make it more difficult for the Reserve Bank of India to cut interest rates. Hence, the risk-averse can invest in debt instruments for a good return.

"Returns from such debt investments for more than a year are also eligible for indexation benefit. Schemes like Escorts Income Fund and SBI Dynamic Bond Fund have generated close to 12 per cent return over the last one year. Tax-free bank fixed deposits also offer benefits under Section 80C, though they have a lock-in of five years," says Acharya.

Life insurance premiums are also eligible for tax benefits under Section 80C if the sum assured is at least 10 times the annual premium. Single premium polices, which offer a lesser cover, will therefore not help you save tax.

"Single-premium products may suit those who have windfalls or erratic income. They are not for the salaried. Also, tax benefits are usually a clincher during sale. Without these, the products lose their shine a great deal. So, one can now skip these products," says Suresh Sadagopan, principal planner, Ladder7 Financial Advisories, a Mumbai-based financial advisory firm.

You can save up to Rs 35,000 (self Rs 15,000 and parents Rs 20,000) under Section 80D by paying medical insurance premiums.

Planning your tax when you jump to the next tax slab
The answer to which instrument will suit your financial plan the best depends on your risk appetite, time horizon, expected returns and the tax bracket you fall in.

"For those in the lowest tax bracket of 10 per cent (annual income Rs 2-5 lakh), traditional bank fixed deposits will work well. They can get 9 per cent assured return without paying too much tax," says Sadagopan. Investing in a bank deposit on a monthly basis is tedious. Consider accumulating money and investing on a quarterly or half-yearly basis.

"Individuals in the intermediate bracket of 20 per cent (annual income 5-10 lakh) can choose between public provident fund, or PPF, tax-free bonds, bank fixed deposits, non-convertible deposits and company deposits for debt exposure. ELSS is a good option for equity," says Sadagopan.

People in the highest tax bracket of 30 per cent, that is, with annual income above 10 lakh, need instruments that give the maximum tax benefits. They can consider investing in PPF or tax-free bonds. Other avenues to reduce taxes are equities and systematic investment plans, or SIPs, of equity mutual funds from which long-term capital gains are not taxed.

"If ready to pay some tax, investors in higher tax brackets than 10 per cent should consider fixed maturity plans or accrual-based debt funds instead of fixed deposits and bonds due to the indexation benefit. Diversified equity funds are a good option if the time horizon is more than five years," says Sadagopan.

Before buying any product, do not forget to look at the basics-inherent risk, return expectation, tenure for which you want to invest, tax benefits and compatibility with overall financial plan.

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