With the budget announced last month, we now know the status of new and existing tax free and tax rebate investments for 2013-14, and in this post I’m going to try and list down each and every investment opportunity in India that gives you a tax benefit of some kind. If you find any missing, please leave a comment and I’ll update the post.
Before going through the individual investments, let’s take a look at the broad categories where they fall.
Tax Free Investments:Â Tax free investments are those investments where the income earned from them is not taxable. For example, the interest that you earn from a tax free bond is not taxable. There aren’t many such investment options available in India.
Tax Rebate or Tax Saving Investments:Â These are investments that reduce your tax liability by subtracting the sum you invest in them from your taxable income. As a result, the total tax incidence on you is reduced as your income on which tax is calculated is lowered.
Tax Arbitrage:Â In this section I’m going to list down some investments that don’t have any specified tax rebate or aren’t tax free otherwise but they offer a tax advantage against comparable investments.
Tax Free Investments
Public Provident Fund (PPF):Â This is the first thing that comes to mind when you talk about tax free investments. PPF is perhaps the best type of tax free investment because it allows you to reduce your tax liability when you invest in it, and then the returns are tax free as well. PPF has a lock in period of 15 years but you can take a loan against your money at 2% interest between the third and the sixth year. They also allow partial withdrawal from the sixth year onwards.Â The current interest rate is 8.70% compounded annually. .
Tax Free Bonds:Â Tax free bonds are a good investment for people in the higher tax bracket as they are issued by companies backed by the government so the risk is quite low, and the returns are quite decent when you consider the post tax yield. In the last two years they have been issued towards the end of the financial year, but you can also buy them from the stock exchange if you missed that window.
The benefit of buying them directly from the issuer is that they usually have what’s called a step down feature, which means that if you buy this bond from the stock market then you get a slightly reduced interest rate. These bonds can’t be more than the corresponding 10 year G-Sec yield, and since interest rates have been going downwards since last year, you can expect tax free bonds that will be issued in 2013-14 to have a slightly lower interest rate than the ones issued this year. This year, the interest rate on tax free bonds has hovered around the 7.50% mark for 10 years.
Maturity Proceeds of Life Insurance Policies: According to Section 10(10D) of the Income Tax Act 1961, Â life insurance policyÂ Â proceeds are tax free as long as the sum assured is 10 times or more the premium paid. I’m generally not in favor of these policies because I feel that there are better options elsewhere if you invest your money in pure term life policies and mutual funds but as far as tax liability is concerned, these policies are tax free. LIC comes up with a few of these policies every year in the tax season so you can look at these at that time to understand them in detail.
Tax Rebate and Tax Saving Investments
Tax rebate investments are generally covered by Section 80C and allow you to reduce your tax liability by investing in instruments that reduce your taxable income. Here is a list of investment options that allow you a tax rebate in some form or the other.
1. Life Insurance Covered Under 80C:Â Life insurance schemes are covered under 80C and you can invest in them to get a tax benefit up to the limit of Rs. 1 lakh within 80C. The limit is applicable on the combined investment under 80C and not just insurance premiums.
2. Pension Premiums:Â Section 80CCC governs exemptions on insurance premiums paid on pension plans. This section comes under 80C and has a limit of Rs. 1 lakh. This means that to calculate how much of a deduction you will get you have to consider other investments made under 80C as well.
3. Health Insurance:Â Section 80D talks gives deductions to premiums paid on health insurance and nny amount paid by an Individual or HUF to an Insurance company as Medical Insurance Premium i.e. premium paid in respect of Mediclaim Policy can be claimed as deduction under section 80D up to a limit of Rs. 15,000 for an individual (Rs. 20,000 for senior citizen). Though not an investment, I’m including it here because I feel it will come up in comments.
4. National Savings Certificate:Â Investment in NSC is also covered under Section 80C and they currently fetch a rate of interest of 8.60%.
5. ELSS Funds:Â ELSS (Equity Linked Savings Scheme) mutual funds are funds that invest in shares, and they also give you a tax rebate. These funds have a lock in period of only 3 years which is the lowest of any investment covered under 80C. I feel ELSS funds are a good way to get started in equities because you get the tax saving and that itself makes the investment relatively safer than other equity investments. However, if you are not comfortable with the volatility of equity then this option is not for you.
6. RGESS:Â A new section called 80CCG was introduced and RGESS funds are covered under that. They are funds that can invest in a specified set of companies in India, and investing in them also reduces your tax liability. They can only be used by first time equity investors, and your income should be less than Rs. 12 lakhs to be eligible under this scheme. The unfortunate part about them is that the way they have been structured, you can only get a maximum tax benefit of Rs. 5,000 and you have to go through a lot of trouble to do that. I think this is a good option for those people who were going to invest in these type of shares anyway, but just the tax benefit of this is not enough incentive for you to buy these.
Â 7. Tax Savings Fixed Deposits:Â These are just like regular fixed deposits but they come with a lock in period of 5 years, and are covered under section 80C. Investing in them saves taxes as well. They usually have comparable interest rate to other fixed deposits of similar time frame, and can be a good option if you are looking for a safe hassle free investment.
8. Deduction of up to Rs. 10,000 on Savings Account:Â In the last budget, sectionÂ 80TTA was introduced which allows you to deduct up to Rs. 10,000 earned from your savings account. You can’t use this for income earned from fixed deposits so you may say that this is not strictly a tax saving investment option, but if you do have earnings from a savings account, use this section to claim tax benefit. As Sanmay points out below, an important thing to remember about this is that you have to proactively claim this deduction as the bank will deduct TDS on your interest unless you instruct them not to.
9. ULIPS: ULIPS are also tax saving instruments as they fall reduce your taxable income as well.
10. NPS:Â There is a new section called 80CCD(2) under which an employer can put up to 10% of the employee’s basic salary plus dearness allowance in NPS and that becomes tax deductible. This is over and above the amount available for deduction under 80C. Now, the key thing to remember here is that there are two parts to the contribution towards NPS, and what you contribute will still fall under the 80C limit, but what your employer contributes is outside of that.
All the uncertainty and changes around NPS has ensured that people aren’t very comfortable investing in it. The vast majority of people who currently invest in NPS are those who don’t have a way to opt out of it. I don’t feel comfortable recommending this to anyone right now but if you are invested in it then might as well take advantage of the tax benefit.
11. EPF (Employees Provident Fund): EPF is covered under 80C so you save tax there and then the interest is tax free as well. Most of you would already have certain contributions to EPF as a large majority of readers here are salaried individuals, and if you have made contributions to EPF then make sure you get the 80C tax benefit from these as well.
12. SCSS (Senior Citizen’s Savings Scheme): SCSS is run by the post office and is meant for people over 60 or over 55 if they have taken VRS. It currently gives you an interest rate of 9.30% and is covered under Section 80C as well.Â Â Â
Tax Arbitrage Investments
1. FMPs: FMP (Fixed Maturity Plans) are close ended mutual funds which invest in debt instruments. You can invest in these for more than a year and be taxed according to long term capital gains rate. The benefit of these are that their returns are comparable to fixed deposits but the income from fixed deposits gets added to your other income and you are taxed at your regular income tax slab.Â Â In this scenario, if you fall under the 30% slab then investing in FMPs can give you comparable returns but the tax is at a lower bracket.
2. Liquid Funds as Opposed to Savings Bank Account:Â Tushar brought this up andÂ I am not sure if this will strictly qualify as a tax arbitrage option or not, but regardless, it is a useful thing to keep in mind, and in the existing high interest rate environment they become a viable alternate to savings account in some cases. Vidya Bala has a detailed post onÂ liquid fundsÂ that I found quite instructive.
I can’t think of any other tax arbitrage investments but if you know one please do leave a comment and I’ll include it.
Looking at investments from a tax point of view is a double edged sword. You want to think about taxability and plan based on it so that you can maximize your returns but at the same time you don’t want taxability to become the driving force behind your investment decisions to such an extent that you ignore everything else.
- Ashish Pandey pointed out that the upper income limit to qualify for RGESS is now Rs. 12 lakhs instead of Rs. 10 lakhs.Â
- Paresh pointed out that Post Office MIS does not qualify for 80C deduction so I have removed that from the list.
- Krishna pointed out that I had missed the newly added Section 80TTA so I have added that.
- Sanmay pointed out clarifying NPS and a useful tip for claiming savings tax deduction.