Any person earning Income has to pay tax. So why are we waiting for the last-minute rush, tax planning and investing to save taxes should not be left for the last minute. Better to start now, this way one can get ample time to carefully plan your tax which will enable us to achieve our target of Tax saving and also helps to accumulate wealth for our future.
There are various tax savings options available under section 80 C of the Income Tax Act, 1961. Now the next step is to figure out the option which offers the highest possible returns.
Here we are going to discuss few such investments which are good tax-saving instruments and simultaneously helps to create wealth in a long term:
- Equity Linked Saving Scheme (ELSS)
Equity is the best investment option that offers a kind of wealth creation opportunity. It holds the potential to beat inflation and generate long-term wealth. However direct investment in stocks does not offer a tax-saving advantage and it is subject to a highly volatile market that needs lots of expertise to create wealth out of it. That is where Mutual Funds come because one can leverage the power of investing in equity but leave the expertise required for equity investing to the domain experts for small fees.
Equity Linked Saving Scheme (ELSS) is one of the best options in the given scenario. ELSS funds are diversified Equity Mutual Funds. One of the important advantages is it has a mere 3 years Lock-in period which is the lowest among other tax-saving instruments at the same time it gives the highest returns.
ELSS funds primarily invest in Equities and Equity Linked Instruments, across the market in terms of sectors and market cap.
Liquidity is also one of the factors of evaluation, the 3 years lock-in with ELSS funds may be a better option for most investors because your money is far more liquid than in other investments.
Due to 3 years, lock-in period Fund Managers can generate better returns because they can take long term strategic decisions as opposed to short term moves in response to investor behaviour when the market is volatile.
SIP in ELSS:
Another good option is to invest in ELSS via SIP. Here one can invest regularly as per our financial goals and it also benefits from averaging during times of volatility.
One can also gain from the power of compounding, which is one of the next best options in building wealth creation. As per the growth option in ELSS funds you stand to benefit from the power of compounding.
E.g. If we invest Rs.5000/- per month (SIP) for 15 years in ELSS then the total investment was only Rs. 9 lakhs and the returns after 15 years would have been Rs.44.5 lakhs.
- Public Provident Fund (PPF)
When people think of building a corpus for their retirement, the first thing that comes to their mind is by contributing to the Public Provident Fund. Public Provident Fund is one of the safe options of investment as it is backed by the government. It gives a fixed rate of Interest annually (7.1% per annum – at present). However, with the current changes proposed in Union Budget 2021, the interest earned will be taxable if the annual contribution is Rs.2.5 lakhs and above.
It is available in all post offices and all public or private sector banks.
The Frequency to deposit in the PPF account is also as per the tax payer’s requirement ie. One can deposit either a lump-sum amount or in instalments during the Financial Year.
E.g. With an investment of only Rs. 5000 per month at 7.1% per annum one can receive approx. Rs. 16.7 Lakhs after 15 years.
It is suitable for investors who want to avoid risk, save for long term goals like child education, marriage, etc without worrying about any capital loss.
Must Read: Portfolio Management Services in India
- Sukanya Samriddhi Yojana
Sukanya Samriddhi Yojana (SSY) is a small deposit scheme for the girl child launched as a part of the “Beti Bachao Beti Padhao” campaign. One of the reasons why this scheme has become popular is due to its tax benefit. It is again backed by the Government so it is preferred by those taxpayers who want to save tax and get good returns without capital loss.
Though this option is available only to those who have a girl child, it is a good tax-saving instrument that fetches the highest rate of interest (7.6% per annum) and also creates corpus in the long run which enables the taxpayer to achieve their financial goals like girl child marriage or for her study purpose.
A Sukanya Samriddhi Account can be opened any time after the birth of a girl child till she turns 10, where you will have to deposit a minimum of Rs.250/- and a maximum of Rs. 1.5 lakhs can be deposited during the financial year. The account remains operational for 21 years from the time it is opened or until the girl in whose name it is opened gets married, after she turns 18 years.
It comes with exempt-exempt-exempt (EEE) status as its annual deposit qualifies for Sec 80 C benefit and maturity proceeds are also non- taxable. The Interest received is also exempt from Tax.
- National Pension Scheme
As the name suggests National Pension Scheme is dedicated solely to retirement planning. It is a pension cum investment scheme launched by the Government of India for the age from 18 to 65 years. NPS is also a good option for wealth creation as your money gets invested across asset classes like equity, Government/corporate bonds, etc.
Here one can have the choice to select our asset allocation which follows an age-based asset allocation model depending on our risk appetite.
It has the dual benefit of investing for retirement and also the best tax saving instrument as it qualifies for EEE status.
Hence the National Pension Scheme can be a good option for those who are not comfortable making investment decisions on their own then such a tailor-made solution can be the best choice and will also build a corpus for their retirement.
- Fixed Deposit Scheme
Fixed Deposits are one of the safest investment options, especially when one compares them with stocks or other market-linked instruments. As the volatility is low the corpus that one set aside in Fixed Deposits serves as a great way to ensure that your capital is safe.
For the investor who is just starting with different investment options, then investing the same amount as your capital is an easy way to arbitrage your risks and receive an assured amount at maturity.
One can also start saving at an early age and multiply wealth with the power of compounding.
- United Linked Insurance Plan
United Linked Insurance Plan is a combination of savings and protection. Along with providing Life Insurance it also helps to channelize one’s savings into various market-linked assets for meeting long term goals.
A Minimum lock-in of 5 years is long term, which ensures investors generating good market-linked returns.
It is good to stay invested in these schemes for a long-term period of say about 10 years or more. Over the long term, ULIP is expected to generate returns ranging from 10% to 12%. The returns from the best ULIP are better than other market instruments like FD’s, NSC’s, PPF, etc. Best ULIP can also beat inflation in the long term.
One can also get a brisk return by exercising the option of fund switching in ULIP’s due to long term investment.
The amount received on maturity is exempt from taxation u/s 10 D of Income Tax Act, 1961. Along with this tax relief, one can also avail of tax benefits on premiums paid up to a maximum of Rs.1.5 lakhs u/s 80 C of Income Tax Act, 1961.
Thus, the objective of wealth creation over an investment horizon of 10 years can be fulfilled by investing in the best ULIP.
It is wise to think of investing beyond the traditional ways of saving tax like, investing in Fixed income tax saving instruments like FD, PPF, or endowment life insurance plans etc. Plan for other options like ELSS, ULIP, etc based on the risk appetite and other relevant factors as discussed above of an individual.
With many options available when investing for wealth creation and saving tax at the same time can be easily achieved by making the right choice at the right time and getting started with it at the earliest.
If you are looking for tax savings this season, then look no more. We have come up with an interesting blog on the evergreen topic of whether ELSS is better than any other tax-saving scheme. And what’s more interesting is that we have also summed up answers to every Why of yours. So what are you waiting for? Let’s skip this journey to the main content.
What options do you have for tax saving instruments?
Income Tax Act allows a deduction from the gross total income if the taxpayer invests in allowed tax saving instruments. There are multiple options in which the taxpayer can make the investments and save the tax impact.
Section 80C of the Income Tax Act prescribes various modes through which the taxpayer can save the tax which is as follows:
ELSS refers to Equity Linked Saving Scheme which are mutual funds that invest 80% or more in equity. These are very attractive from viewpoint of returns but carry little more risk as compared to other saving alternatives.
PPF refers to Public Provident Fund which requires the taxpayer to open the PPF account in any of the authorized banks. Lock-in period is 15 years with partial withdrawal allowed once in a lifetime.
Life Insurance Premium
Life Insurance Premium paid towards self and family are allowed as a deduction under section 80C of the Income Tax Act.
These are 5 years term deposits that can be maintained with any bank. However since the interest rates are falling, Bank Fixed Deposits are a little lesser attractive from the perspective of tax saving.
NSC refers to National Saving Certificate as another tax-saving instrument that has a lock-in period of 5 years. It has a guaranteed return which changes periodically.
ULIP refers to Unit Linked Insurance Premium which can be said as a combination of mutual fund and insurance. This is more of an insurance product with investment component in it.
Why ELSS is better than any other tax-saving instruments?
- Higher returns as compared to other conventional investment instruments
- ELSS has wide exposure to the stock market which makes it a very lucrative and attractive option for tax saving as well as wealth building.
Even though there was some impact on the stock market due to pandemic, the stock market has bounced back up. This has resulted in a huge surge in absolute returns derived by the ELSS especially.
In all, ELSS comes with higher returns even if not guaranteed, around 12-15%. In every sense, it beats the inflation rate.
High liquidity due to the lowest lock-in period
ELSS has the lowest lock-in period of 3 years which can be termed as lowest as compared to other tax-saving investments which are a minimum of 5 years.
Since ELSS has the lowest lock-in period, it is suited best to short-term to medium-term financial goals also. Hence, it allows the investor to manage the liquidity position in a short time span.
Highly flexible mode of investment
ELSS allows you to switch between the mutual funds pertaining to the same AMC (Asset Management Company) or any other AMC. Some of the ELSS also allow switch options within their AMC as a mandate action discretionary upon the investor.
Single Demat account required
ELSS investment needs to be made through a Demat account which can also be used for investing in shares and securities. So investors get to invest in various types of instruments in a single Demat account. This helps the investor to keep a single control over investments.
Why choose ELSS over other saving instruments?
|Type of Instrument||Linked to the stock market since almost 80% or more is invested in equity||Government-backed saving instrument||Combination of equity/Debt exposure and a portion of insurance where insurance is the core service area||5 years term deposit with any bank|
|Lock-In Period||3 years||15 years||5 years||5 years|
|Risk %||Moderate to high||Low since the returns are guaranteed by the government.||Moderate to high due to a combination of equity exposure and insurance portion.||Low since they carry a fixed rate of interest|
|Return||Highest return in the brackets of the tax-saving instruments around 10-13% or even more provided high-risk appetite is assumed||Fixed-rate of return is prescribed by the government which may or may not be changed periodically. However the current rate of return revolves around 7.10%-7.60%||Even if the ULIPs have absolute returns of 10-12%, most of the portion of returns is allocated towards mortality costs etc. hence it impacts the effective return in the long run.||Fixed Deposits have interest rates of 6.5% -7% currently. Due to falling interest rates, it is difficult to predict whether the bank FD rates will pick up 0r further go down which may seriously affect the effective return|
This gives us the fair idea that investors should go for ELSS if they have a moderate to high-risk appetite and desire to earn lucrative returns. ELSS is a dynamic form of investment that can be used as a tax-saving instrument as well as a wealth-building tool. It is always up to the discretion of the investor whether to go for a decent rating and moderate returns, which is a good combination of risk-reward ratio. Nevertheless, it comes at a low cost and also can be invested in lumpsum or SIP which makes it easier to maintain liquidity. In all, a win-win situation for the investor.
“Bank Fixed Deposits are not going to work for me! I am planning for building up a fund for paying off my daughter’s college fees.” Mr. Iyer was telling me the other day.
“I want to know where I can invest for 5 years so that I would be able to pay off the college fees easily after 5 years?” Mr. Iyer was indeed worried because he is not able to understand how to work this out.
Mr Iyer is a representative example of the common man to whom any of us can relate to. There are so many financial instruments in the market, then how to choose the correct one suited for our financial goal. Let’s see in this case study where Mr Iyer can invest fruitfully for 5 years in ELSS vs PPF Public Provident Fund
Let’s understand what are ELSS (Equity Linked Saving Scheme) and PPF (Public Provident Fund)
ELSS refers to Mutual Funds that invest 80% or more in equity i.e. shares and securities. ELSS is one of the primary tax saving instruments which has a lock-in period of 3 years. Investors can invest in ELSS in a lump sum or through SIP (Systematic Investment Plan). SIP requires that the investor should invest a fixed monthly amount in a selected ELSS fund.
Read more about ELSS Funds – 7 Reasons Why ELSS Has Evolved Into A Popular Tax Saving Alternative
PPF refers to another tax saving instrument which is a rather long term investment term of 15 years. The investors would be required to open a PPF account wherein he is required to invest monthly or annually.
The differences between ELSS and PPF
|Lock-in period||An investor needs to stay put in ELSS for the minimum period of 3 years to get a tax deduction benefit on the investment under section 80C||Lock-in period for PPF is 15 years which is much higher as compared to ELSS.|
Even though partial withdrawal is allowed after 5 years, substantial money will still be blocked till maturity.
|Liquidity||Due to 3 years lock-in period, the investor can easily redeem or sell to quench its liquidity needs||Due to greater lock-in period, PPF can be touted as an illiquid instrument, more suited to long term financial goals like retirement planning etc.|
|Returns and risk ratio||ELSS has a moderate to higher risk and returns ratio since 80% or more of the funds are allocated towards shares and securities in the open market. Returns could be on an average 10-13% p.a. The risk could be in the corresponding % due to market uncertainty||PPF has a lower risk-return ratio since it is a government scheme. Returns could be around 7-8% as dictated by government. Risk is very less since the returns are guaranteed by the government|
|Taxation||Investment in ELSS is covered under section 80C deduction, however, the capital gains are taxable above the limit of Rs.1 lakh||PPF has an EEE structure meaning that investment, returns, as well as maturity proceeds, are exempt from the income tax purview.|
Let’s compare ELSS and PPF for Mr. Iyer
I showed all this data to Mr. Iyer who was again confused, “Anna, it looks like both ELSS and PPF have their pros and cons. How would I know which one is better for me?”
So here is the comparative chart where it is assumed that Mr. Iyer invests Rs. 5000/- per month in ELSS and PPF.
|Year||The amount received annually if Rs.5000 invested in ELSS||The amount received annually if Rs.5000 invested in PPF|
*assuming that ELSS earns a rate of return around 11.5% and PPF earns around 7.1%
Analysis of the case study
- Looking at lucrative returns earned by the ELSS, ELSS definitely makes a good option for a 5-year investment option
- However, while considering the higher rate of return, we also must attach the risk carried by ELSS in the form of unguaranteed returns and loss of principal.
- PPF returns even if secure and easiest way for investing, definitely takes a toll on the liquidity stature of the investor. Since PPF allows only partial withdrawal after 5 years, there is no chance that Mr. Iyer could take out money before that threshold.
- PPF is the most secure form of investment since it is backed by the government. Even if the rate of return does not factor in the inflation cost, there is no default risk or market risk in PPF.
- If we keep on populating the returns for both ELSS and PPF for a longer period, ELSS would bag the surge in returns in the long term considering that markets will be in the progressive mode of operation.
I suggested Mr. Iyer take an independent decision based on the below pointers. Hope it helps you all too to take a big leap.
- If Mr. Iyer wishes to conserve the capital and is wary of the stock market, then he can put his money in PPF. This would give him the guaranteed returns and security of principal invested. However, the con side to this would be
- Comparatively lower returns
- No inflation factoring of returns
- The long term Lock-in period of 15 years resulting in a liquidity crunch
- If Mr. Iyer has a moderate to high-risk appetite, then he can think of putting his money into ELSS funds to secure a higher rate of return. ELSS would be a very liquid asset as well as a high return bracket. However, there are few risks to think of
- Loss of principal due to market risk
- Unguaranteed returns
- Alternatively, Mr Iyer can divide his investment in PPF and ELSS to reap higher returns and square off the losses.
PPF is one of the most popular tax saving as well as investment instrument as it comes with EEE tax framework. Additionally, PPF comes with so many features that it is difficult to resist. This article will focus on everything related to PPF.
What is PPF?
PPF refers to Public Provident Fund. This is a unique investment instrument which comes with long term time horizon. It is best suited for long term financial goals like marriage or education of the kids or retirement planning.
Features of PPF
- Tax saving
PPF can be used as tax saving instrument as investment in PPF comes under section 80C for claiming deduction from the taxable income.
Additionally, due to its EEE structure, PPF gives out exempt income and exempt maturity along with tax free deductions (80C deduction for accumulation or investment amount).
- Interest rate
PPF interest rate is directly linked to market interest rates. Recently, Government announced that small savings interest rate will be set quarterly and would be linked to comparable government securities. So, from now onwards PPF interest will be directly impacted by government securities interest rate and it will never under perform this secure benchmark. Currently this interest rate is around 8.1%, which will of course keep on changing to keep in pace with the market interest rate.
- Lock in period
Lock in period for PPF is 15 years, hence it is most suitable for long term financial goals. Even though partial withdrawal is allowed, it is only after completion of 5 years from opening the said PPF account. Further amount can be withdrawn only for certain emergencies like medical emergencies etc. and there is upper cap for the same.
- Compounding effect
Due to the longer lock in period of 15 years, PPF can beat other instruments based on compounding or accumulation effect.
Since, withdrawal (partial) is allowed only after 5 years, interest on corpus invested gets compounded at existing interest rate at least for 5 years and at maximum for 15 years. So, if you invest Rs.100 each year for 15 years today in PPF, you will get around Rs.2963 in 15th year.
- Liquidity factor
PPF being a long-term investment instrument, liquidity crunch may be a biggest hurdle. During the whole tenure, only after 5th year, the PPF investor can withdraw partially.
Even if the investor decides to stay put in the PPF investment, funds invested as well as interest on it will be locked in for 15 years.
Why PPF is to be opted for?
- Tax free returns
Since PPF comes under EEE framework, the interest on PPF investment will be exempt. This interest gets compounded annually and at the time of maturity, you will get enhanced amount which is absolutely tax free i.e. tax free interest + tax free corpus (principal).
- Reasonable return
PPF interest rate is linked to government securities interest rate. This interest rate is set quarterly;however, this ensures that PPF will never disappoint the investor. This benchmark ensures the safety in the sense that it will never dip down that mark.
- Smallest investor can participate
PPF can be opened and kept alive only with a meager investment of Rs.500 which makes it possible for even a smallest investor to take benefit of long term compounding.
- Attractive as compared to conventional saving instruments
Suppose if you invest in Bank Fixed deposit which gives out interest rate of 7.5 – 8%, which are before tax and not factored to inflation effect.
On the contrary to this, PPF returns are after tax returns and can battle with inflation till maturity due to compounding effect.
- Best retirement planning instrument
Being most safe saving instrument, PPF can be effectively used in retirement portfolio. Point to be noted is that, you should invest more and more at much young age, which would benefit you by enhanced compounding effect.
Points to be noted
- You should first identify your long term financial goals and invest in long term investment instruments like PPF. This would enable you to match payout date and maturity date (which will ease your liquidity position).
- PPF investment is capped at upper level for Rs.1,50,000 and hence one cannot invest more than that threshold limit.
- NO permanent closure of PPF account is allowed prematurely. This leads to lack of flexibility.
- PPF rates keep on changing and may even decline if there is rate cut. However, it will never go down its benchmark rate of interest.
- As compared to ELSS or other newer investment options, PPF lags on flexibility and inflation adjusted returns factors. However, it is suitable for risk averse and conventional investor.
- It can be opened at any post office, or any prescribed nationalized or private banks.