Did You Know...Tax Saving ≠ Investing?

Did You Know...Tax Saving ≠ Investing?

"The one that follows the crowd will usually go no further than the crowd. The one who walks alone is likely to find themselves in places no one has ever been." – Albert Einstein

Every year, from January to March, we find ourselves scrambling to find tax-saving investment schemes that qualify under Section 80C. There are a number of investment products that boast of being eligible under this tax saving scheme. But before jumping on that bandwagon in the hope of saving some tax, you must first analyse whether these investments are really all that they are made out to be and, more importantly, whether you even need them in the first place!

What You Should Know About Tax-Saving Products

Before you choose one of the many tax-saving options available under Section 80C, you should carefully consider the key features of each of them and what they mean. The three most important factors to take in to account are expected returns, lock-in period and tax implications of the final returns.

Scheme Description Returns* Lock-in Taxation
National Saving Certificates NSCs are available in 5 and 10-year maturities 8.50% and 8.80%, respectively Same as maturity Accrued interest is taxable, but qualifies for 80C
Equity Linked Savings Scheme (ELSS) ELSS is an open-ended mutual fund specifically created for tax saving which invests in diversified equities Market dependent (12-14%) 3 years Dividends and long-term capital gains are tax-free
Life Insurance Policies Premiums paid towards life insurance of self, spouse and children are included here Depends on the scheme Depends on the scheme Depends on the scheme
Unit Linked Insurance Plans ULIPs are insurance policies that also provide return on investment linked to the equity market. Market dependent (8-10%) Depends on the scheme (usually 15-20 years) Interest is tax-free
Infrastructure Bonds Bonds issued by Infrastructure companies Market dependent 3-10 years Interest is taxable
National Pension Scheme Upto 50% of the investments are in equity products and the proceeds at the time of maturity are taxable. There is also no guarantee of returns generated. 8-10% Till retirement Interest is taxable
Contribution to Provident Fund PF is usually automatically deducted from salary. The employee’s contribution is counted towards the 80C exemption, including additional amount through voluntary PF 8.70% Till retirement Interest is tax-free
Public Provident Fund PPF is one of the most commonly used tax saving instrument due to its relatively high returns which are also completely tax-free 8.70% 15 years, partial withdrawals allowed after 7 years Interest is tax-free
Bank Deposits Certain fixed deposits offered by scheduled banks are entitled for exemption Varies (8-9%) 5 years Interest is taxable
Senior Citizens Savings Scheme Offered by the Indian Postal Service, this scheme for people over 60 years of age has an investment limit is 15,00,000 9.30% 5 years Interest is taxable
Post Office Time Deposit 5-year maturity deposits are eligible for 80C deduction 8.50% 5 years Interest is taxable
Interest accrued on NSCs Interest earned on past years’ NSC investments -NA- -NA- -NA-
Tuition Fees School or college tuition fees for full time education of any two children is deductible -NA- -NA- -NA-
Repayment of Home Loan Principal Principal component of the EMI of a home loan is deductible, provided the home is ready to live in during that year -NA- -NA- -NA-
Stamp Duty & Registration Charges on Purchase of the House The amount paid as stamp duty when buying a house, and the registration fees of the documents of the house can be claimed as deduction -NA- -NA- -NA-

Investing Is More Than Tax-Saving

The instinct to save comes naturally to most of us. But saving a few bucks by reducing your tax liabilities will not set you on the path to long term investing. Tax saving is just one of the many steps that you must take in order to build towards a financially secure future. Let’s take a quick look at the numbers to understand this better.

Although it seems logical that saving as much tax as possible is good, but does that necessarily mean that you make the most returns by investing in tax-saving schemes and products? Take the example of Kabir. His income falls in the 30% tax bracket and he has a life insurance policy and an EPF account where he puts in 1,00,000 in total. That means he has another 50,000 that he can invest in tax-saving schemes under the Section 80C.

Scenario 1

Kabir invests the 50,000 in an ELSS mutual fund, that gives an average return of 14% every year. This amount is now tax-exempt and he doesn’t have to pay taxes on the future profits as well. In ten years, his 50,000 investment will grow to 1,85,361.

Scenario 2

Kabir decides not to invest in one of the tax-saving schemes. He invests in a different product where his annual earnings are 19% (5% more than ELSS). Since the investment does not qualify under Section 80C, he has to pay 30% of 50,000 as income tax, leaving only 35,000 for investing. After ten years, his 35,000 investment will grow to 1,99,314.

Surprised? That’s something most financial agents don’t want you to know because they make higher commissions selling tax-saving products like ELSS’ and ULIPs. In the above example, we assumed a difference of only 5% in the annual returns and the highest tax bracket of 30%. Most ELSS funds give much lower returns than that compared to regular equity mutual funds and stock portfolios. ULIPs are even worse and give almost half the returns of regular investments. In most cases, you would be better off paying the income tax and investing the remainder in a regular equity mutual fund or direct equities rather than investing in tax-saving products and getting lower returns over the next 5-10 years! Add to that the high lock-in period of tax-saving investments and stop looking so attractive after all.

When Does It Make Sense To Invest In 80C Schemes?

Go through the list of schemes that are available under Section 80C. You will notice that a number of them, like PPF, NSC and Post Office Deposits, have fixed returns that are not linked to stock market performance. A well-balanced investment portfolio must contain a portion of investments allocated to fixed income products.

Take the Investing Traits quiz to find out how much you should invest in fixed income products.

It makes perfect sense to invest in such schemes to get the advantage of tax-saving as well as the security of long-term fixed returns. There are also certain options that cover payments you would, in any case, incur. Children’s tuition fees, life insurance premium and home loan principal repayment are some of these options. You should take these into account before looking for other tax-saving investments.

Just remember, when it comes to investing, you must always understand what you are investing in. And after weighing the pros and cons of all available options, make an informed decision rather than blindly following the rest of the herd.