The approach to tax planning has to be holistic; it cannot be treated as once-in-a-year ritual that has to be casually looked at, at the end of the financial year, writes DEEPALI SEN.
Last quarter of every financial year is that time of the year when most of us are involved in hectic activities around choosing and deciding upon, from the common choices made available by the Government of India. Now we only have time until March 31, 2015 for this financial year. As per the Finance Act (No.2), 2014, the investment limit under Section 80 C of Income Tax Act, 1961 has been increase to Rs.1.5 lacs.
Since there are various options one can choose from, the key parameters to weigh these choices are on the investment trinity of liquidity, returns and risk. Furthermore, what may work for one investor may not work for the other one. It is more like using different strategies for different pitches.The most common choices available at hand are:
PPF (Public Provident Fund) & NSC (National Savings Certificate)
- On liquidity: While they have a fixed tenure, both are widely different.
- PPF has a maturity of 15 years (with it being renewable for another 5 years), NSC, VIII issue is for 5 years and NSC, IX issue is for 10 years. However, for PPF it is important to know that after the third financial year, excluding the year of the deposit, an investor is allowed to take a loan on his investment. Partial withdrawals are permissible after the expiry of the fifth year from the date of the initial subscription.
- On risk: Both of them are backed by the government, so score high on risk parameter (in terms of being low on exposure to risk)
- On returns: Both of them are fixed returns products and the rate gets set at the start of the financial year. Also, these returns are handed over to the investor (cumulatively) at the time of maturity
- The current rate for PPF is 8.7% per annum, for NSC VIII it is fixed at 8.5% and 8.8% per annum for NSC IX.
- The return of PPF is compounded annually whereas that of NSC is compounded half-yearly.
- The PPF returns may or may not vary every year, but the returns of NSC stay insulated from changesuntil maturity once it’s bought.
- The other key differences lie in the tax applicability at maturity and in the amount that can be invested
- PPF offers a deduction all the way, known as EEE – implying exempt-exempt-exempt. What this means is that you get a deduction when you invest under Section 80C, the interest earned every year is exempt from tax, and the entire amount at maturity (principal + interest earned) is also exempt from tax. In the case of NSC, it is EET, which means the interest at maturity is taxed.
- In a financial year (starting this year), one cannot invest more than Rs.1.5 lacs in PPF, whereas in NSC there is no maximum limit.
To wrap up the debate of PPF Vs NSC; the latter has better pre-tax performance due to current returns (8.8% of NSC IX over 8.7% of PPF) and the fact that the same is compounded half-yearly over PPF’s annual compounding; but the post-tax implications nullify this benefit. In addition, we know that NSC scores better on liquidity or lock-in.
NPS (National Pension Scheme)
- On liquidity: Investors aged 18-55 can invest, but the investments made cannot be withdrawn until the client turns 60. Even then, 40% of the corpus has to be utilized for purchasing a life annuity.
- On risk: It has various options available in terms of asset allocation, the maximum being- 50% of exposure to equities through the stock market.
- On returns: The returns are not fixed, they are market dependant (both fixed income market and equity markets, depending on how much goes where)
- NPS (Tier I) continues to be EET, which means that the returns are taxed at maturity.In addition, the maximum amount which can be invested is 10% of basic salary and the dearness allowance paid.
While the returns of NPS are not fixed, the fact that it’s linked to the markets and the expenses are low, the probability of making decent returns (upwards of inflation) goes up. However, its EET nature makes it relatively unattractive along with the reality that the investments have to be held until60
Tax saving is more than just investments and goes beyond Section 80C. If you have donated to a charity that offers a tax deduction, avail of it. If you are paying premium on a medical insurance policy for yourself and dependents, be sure to claim the deduction.In addition, if you are servicing a home loan or an education loan, you are eligible for income tax deductions. Under Section 80C, you can even show the expenses of your child’s education to avail of a deduction.
Fundamentally, the approach to tax planning has to be holistic; it cannot be treated as once-in-a-year ritual that has to be casually looked at, at the end of the financial year. The three key pillars of investing, liquidity, returns and risk have to be at the core, while deciding; saving of tax is a largely peripheral but cannot be ignored either. It’s important to ensure that the tax saving investments (too) help your total portfolio returns tide over the inflation mark.
(The writer is a certified financial planner and author of ‘Why greed is great’)