Read on to know how you can generate wealth and also save taxes
09-Aug-2022 •Ravi Banagere
Many people start thinking about tax-saving investments in the last quarter of the financial year when they are nudged by their employers to submit tax proof. Their mental wiring becomes such that all they want is to dump money somewhere that gives them a tax benefit. And in a rush, most people fall prey to the next sales guy they meet. In this entire process, proper evaluation and suitability analysis of the investment instrument itself takes a back seat.
For those who are methodical enough, tax planning might start much earlier, maybe at the beginning of the financial year. But there too, many people do not care to understand all the possible tax-saving options in order to pick the best one for them. What you need to understand is that an ideal tax-saving investment must be a good investment first and a tax-saver later.
Many instruments have been so popular for ages that we blindly put our money there. Mostly on the fixed income side, some of those instruments are Public Provident Fund (PPF), five-year bank FDs, National Savings Certificate (NSC), etc. The biggest problem is these investments provide guaranteed returns but they fall short when you adjust them to inflation. Equity as an asset class has the potential to beat inflation and make you earn real returns. It is for this reason that your long-term portfolio should have significant exposure to investments in equity.
Among all the tax saving options, the ones that invest in equity include National Pension Scheme (NPS), unit-linked insurance plans (ULIPs) and tax saver funds (ELSS). NPS is a good option but comes with a very long lock-in period and while ULIPs are marketed aggressively, they neither provide adequate insurance nor good returns. You can read about our comparison between ULIPs and ELSS. Hence, ELSS comes out as an attractive option that can suit most individuals.
Let's compare PPF which is one of the most popular tax-saving options with ELSS. PPF offers tax benefits on contributions as well as withdrawals after the lock-in period. This scheme is backed by the government and provides a safe and regular income post-retirement. Most people get attracted to the guaranteed interest and tax saving aspect and enrol themselves into this scheme. But they tend to overlook the return aspect. Equity-linked savings scheme (ELSS) solves the low inflation-adjusted return problem since they invest in equity. These mutual funds are similar to the flexi-cap funds if you compare the style of investment. These do not have any restrictions while investing and can invest in companies irrespective of their size.
ELSS investors have earned a healthy return over the past years vis-a-vis PPF investors. If we compare the returns of the two, we'd be shocked by the stark difference. Here is an example to help you understand this. Suppose you had invested Rs 12,500 every month for the past 20 years starting June 2002 in an ELSS fund and PPF. Since these schemes offer a tax deduction of up to Rs 1.5 lakh in a financial year under section 80C of the Income-tax Act, it translates into monthly investments of Rs 12,500. In these 20 years, you would have invested about Rs 30 lakh overall. The ELSS investor would have accumulated a corpus of Rs 1.74 crore, whereas PPF would have made you Rs 74.50 lakh. That's a difference of about Rs 1 crore! This is based on the category average returns for ELSS and the actual interest rate for PPF for the respective period.
Since gains on equity mutual funds are taxable, the post-tax returns on ELSS would be slightly less but it would still handsomely beat the fixed-income tax-saving options.
Besides this, ELSS funds have another hidden benefit - a three-year lock-in period. This lock-in period can be a great way for new investors to taste equity investing without running the risk of taking money out in panic. Thus, ELSS investments can not only help you save tax but also build wealth for your future.