What are the rules or the strategy that one should adopt while investing to save taxes?
Dhirendra: Tax saved is money earned. 80C is a very simple provision which allows you to reduce the taxable income by up to Rs 1.5 lakh, through certain eligible investments and expenses. And the mandatory EPF deduction, which most people have is also eligible for it.
So from Rs 1.5 lakh, first deduct the amount that you are contributing towards EPF. The remaining amount is what will get you an additional tax-break on investing. Once you are done with this calculation, look for the resources to invest and save taxes. If you have enough resources, there is another section, 80CCD (1B) which gets you additional deduction of up to Rs 50,000 on investing in the National Pension Scheme (NPS).
What about life insurance?
Dhirendra: Lots of people have this long-term commitment; it is also an eligible investment under Section 80C, but it may not be a very wise investment. Reconsider that. One should not buy investment-linked life insurance primarily to save taxes. Though you save on taxes, you lose on the return.
If you have financial dependents, you must buy adequate life insurance. That should be a priority. But for this, purchase a term plan only. Look at it as a cost. The premium that you pay for it is also eligible for deduction under 80C.
So where should one invest the remaining money after deducting the EPF contribution and term insurance premium?
Dhirendra: Equity linked savings schemes (ELSS) are the finest alternative. Broadly, you have two kinds of investment avenues. One is that you invest in ELSS. That is the only equity alternative. And the other is a wide range of fixed-income products - Senior Citizens Savings Scheme (SCSS), Public Provident Fund (PPF), five-year bank deposit and so on. They get you a guaranteed return which is fixed. But ELSS holds the promise of high return. And all these tax-saving investments come with a lock-in period. My suggestion is that when you are getting locked in, you might as well generate a higher return.
So therefore you suggest going for ELSS over PPF?
Dhirendra: Yes. Most people do a recurring deposit in PPF for 15 years and it also gets them the tax break. The income from PPF is absolutely safe, it is guaranteed. But the return is something which is not adequate. When you're regularly investing with a 15-year time frame, I think ELSS will turn out to be a far more rewarding option.
What about NPS?
Dhirendra: NPS is an additional thing. I think one should not consider it as a primary tax-saving alternative under 80C. You can get a tax- break of up to 2 lakh by investing in NPS, if you combine both 80C and 80CCD (1B). But I would suggest to first exhaust your 80C by investing in ELSS after the mandatory deductions and the term insurance premium. Only after that, if you have additional resources, invest in NPS to get the additional tax-break.
What if someone does not have enough money to invest in all that you have mentioned? Are there any other ways in which they can claim deductions?
Dhirendra: Yes. If you have young children, the tuition fee that you pay for up to two children is also eligible under Section 80C. And one should utilise the provisions for taking a deduction for the house rent that you pay. Even if you do not get HRA, you can claim a deduction of up to Rs 60,000 on the house rent that you pay. Besides, if you have a home loan, the interest paid of up to Rs 2 lakh is eligible for deduction.
Besides all of this, there is one trick which I think everyone should aspire for. If you are very limited on resources but saving taxes is important, somehow you should work towards saving and investing in ELSS for at least three years in your life. And after that, because the lock-in in ELSS is just about three years, you can start recycling that money. Once your first investment is free from the lock-in after three years, take that money out and invest again. You can repeat the same practice with your second and third year investments in subsequent years. This way you can save on taxes by recycling the old investments in ELSS.
Would you like to caution investors on any common mistakes that they should not make while investing to save tax?
Dhirendra: The starting point should not be to save taxes. Look at them as investments first. And don't wait for the last minute. Because at that point what happens is that normally you choose the not so great investment and you get the tax break, but you don't generate enough return. It's a huge compromise on an opportunity.
You should use this avenue in terms of maximizing return because you are locking your money for a long period of time. And the one most common mistake which every investor makes is that they buy an investment-linked insurance plan - an endowment plan or a unit-linked insurance plan (ULIP). It also becomes a long-term commitment which you can't undo. Once done, you are stuck with it for a long period of time.
Before we end today's discussion, can you please summarise the advice given by you?
- Avail 80C to the extent possible. Computing it is pretty straightforward. You are eligible for a deduction of up to Rs 1.5 lakh. Your provident fund contribution is also counted as an eligible investment for it. So subtract your EPF contribution from Rs 1.5 lakh, that is the money that can get you additional tax relief, if invested in eligible investments.
- The best investment avenue for tax saving is ELSS because it comes with the shortest lock-in period and has the potential to generate the highest possible return for you.
- Avoid investing in ULIPs and endowment insurance plans.
I'm just reminded of one more thing which I would like to add to this. For many investors, it gets very hard to save besides the investments for saving tax. Somehow, if you are able to save this Rs 1.5 lakh, put it in ELSS and keep doing it for 15-20 years. Do nothing else. If you don't touch this money, it can well become one of the best performing retirement plans for you. It can accumulate into a very sizeable corpus for you. And the three-year lock-in period will also enforce discipline.
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