As the financial year draws
to a close, we all start feeling the heat and realise that yes, now we have to
invest in order to save tax. Whilst investing with tax saving and tax planning
in mind is the key, these investments must be part of a larger financial plan –
to achieve certain life goals and protect capital. Unfortunately, tax planning
decisions are taken at the eleventh hour with low planning and thus hamper the
process of wealth creation over the long term.
Ideally, you should commence your tax
planning exercise well in advance, complementing it with your overall
investment planning exercise. This will ensure that you select the tax saving
instruments which will eventually help you to meet your goals.
In order to get your thoughts moving,
we have broken down the tax planning exercise into 3 simple steps:
Step I – Compute the Gross Total
Income
The process of tax planning begins
with computation of your gross total income. Gross total income is nothing but
the sum total of income from various sources which includes income from salary,
income from house property, profits and gains from business & profession,
capital gains (short term and long term) and income from other sources. You can
do this by yourself, get it done at your office (many offices do offer this
facility), ask your CA / tax consultant to do it, or use the convenience of the
new tax portals that have emerged in more recent times. E.g. http://www.incometaxindia.gov.in/Pages/tools/income-tax-calculator.aspx
Step 2- Compute the Net Taxable
Income
The next step is to compute the net
taxable income. This means reducing from the gross total income, the various
deductions allowed under the Income Tax Act, the most common being
deduction under House Rent Allowance and Section 80C. Section 80C allows for
deduction upto Rs 150,000 p.a. for specified payments and investments. Common
examples are – investment to Public Provident Fund (PPF) , payment of life insurance premium, employee’s contribution to Employer’s
Provident Fund (EPF), and repayment of principal amount of a home loan. Section 80D –
Section 80D allows for deduction upto rs. 15000 for medical premium and medical
check up you can claim for additional 15000 for parents (20,000 incase senior
citizen) , Section 24B for interest on Home loan (Calculation varies in case nature
of property occupied)
Step 3 – Calculate the tax
payable
Once the net taxable income is
computed, the final step is to calculate the tax payable based on the current
applicable income tax slabs.
The income tax rates for
Individuals and HUFs for FY 2014-15 can be checked at the following :-
India Income tax
slabs 2014-2015 for General tax payers and Women
Income tax slab (in Rs.)
|
Tax
|
0 to
2,50,000
|
No tax
|
2,50,001
to 5,00,000
|
10%
|
5,00,001
to 10,00,000
|
20%
|
Above
10,00,000
|
30%
|
India Income tax
slabs 2014-2015 for Senior citizens (Aged 60 years but less than 80 years)
Income tax slab (in Rs.)
|
Tax
|
0 to
3,00,000
|
No tax
|
3,00,001
to 5,00,000
|
10%
|
5,00,001
to 10,00,000
|
20%
|
Above
10,00,000
|
30%
|
India Income tax
slabs 2014-2014 for very senior citizens (Aged 80 and above)
Income tax slab (in Rs.)
|
Tax
|
0 to
5,00,000
|
No tax
|
5,00,001
to 10,00,000
|
20%
|
Above
10,00,000
|
30%
|
Take prudent steps to minimise tax
liability
Between step 1 and 2, i.e.
before you start calculating your tax liability and decide where to
invest your money to save tax, it is important for you to know the parameters
on which you should select the tax saving instruments. The most important ones
include your:
·
Financial goals
·
Age
·
Risk appetite
·
Investment horizon (only to an extent, as most of the instruments have a
lock-in period of 3 years)
Based on the above parameters, work
out your asset allocation (for the tax saving investments). If you are young,
then allocate more money to higher risk instruments like Equity Linked Savings
Schemes (ELSS) and a smaller portion to safer instruments like PPF/EPF. As you
grow older and near retirement, keep increasing your allocation to EPF/PPF and
reducing the same to ELSS.
It should be noted that tax planning
enables you to also create wealth for retirement planning, as every year you
contribute to the retirement corpus. Starting early will help you in two ways:
·
Reduce pressure on finances at a later stage and
·
Enable you to aim for an ideal retirement scenario and not a compromise
All you need to know about Section
80C
Section 80C of the Income Tax Act provides
a maximum deduction i.e. upto Rs 150,000 p.a. for individuals and HUFs. The
investments and contributions under Section 80C can be broadly classified into
three categories – life insurance, assured return schemes and market-linked
schemes. It is important to reiterate that the aggregate of all investments
under Section 80C, subject to any sub limits, cannot exceed Rs 150,000 p.a.
Following are the major, more popular
and common investments/contributions that qualify for Section 80C deductions:
·
Life Insurance Premium
·
Public Provident Fund (PPF)
·
Employees’ Provident Fund (EPF)
·
National Saving Certificate (NSC) , including accrued interest
·
5-Year fixed deposits with banks and Post Office
·
Senior Citizens Savings Scheme (SCSS)
·
National Pension Scheme (NPS)
·
Unit-Linked Insurance Plans (ULIPs)
·
Equity Linked Savings Schemes (ELSS)
·
Tuition fees paid for children’s education (maximum 2 children)
·
Principal component of home loan repayment
(The above list of
investments/contributions is not exhaustive.)
Life insurance: Forget the tax
benefits
Tax saving and life insurance are
synonymous in the Indian context. Think of life insurance and the first point
that comes to mind is tax saving. This is because premium paid on any life
insurance plan can be claimed as deduction under Section 80C of the Income Tax
Act. In fact, tax saving and life insurance have become so closely associated
with each other, that life insurance for many individuals is reduced to just a
tax saving avenue. While the truth is, regardless of the tax benefits, life
insurance is a potent tool that every individual must have in his financial
portfolio – not as a tax planning instrument but as an insurance against an
eventuality.
The blame for equating life insurance
with tax benefits must be shared equally by both insurance companies and life
insurance agents. Most insurance companies focus on the tax saving aspect of
life insurance more than any other feature. Insurance agents heighten their
efforts to sell insurance in the latter half of the financial year (September –
March) because they understand that, that is the time individuals (particularly
salaried employees) tie up their tax planning.
Not that we at do not have any
complaints against tax benefits being offered on life insurance. But the tax
benefits have served as a distraction and have detracted from the real benefit
of taking life insurance i.e. providing financial security to the
individual’s dependents. The prudent approach to taking life insurance involves
putting the primary reason (securing the dependents) ahead of the secondary
reason (tax benefit). Look at it this way, if you have not taken life insurance
for an amount that accurately provides for your family in your absence, you are
hurting your own family’s cause. That is why it’s more important to take life
insurance according to your needs rather than to maximize tax benefits.
How to buy life insurance
First, you must determine the tenure
over which you wish to take life insurance. For married individuals, this
should be the estimated remaining lifespan of your spouse. Then you must
determine your liabilities (like home loan, education loan) and expenses (like
household expenses, medical expenses) that your dependents will have to service
in your absence. Next, you will also have to factor in inflation to arrive at
an estimate sum that is commonly referred to as your ‘Human Life Value’ (HLV).
Finally, you must opt for a suitable insurance plan to provide for your HLV.
There are primarily 3 types of plans that you can choose from.
1. Term Plans
Taking a term plan is the most
cost-effective way of buying life insurance. Term plans only provide an
insurance cover and do not offer a return. If the policy holder survives the
policy tenure, he will not receive any maturity benefit.
On the other hand, if he meets with
an eventuality (i.e. death) during the policy tenure, then his dependents get
the sum assured. Term plans allow individuals to opt for a larger sum assured
at a relatively lower premium. For individuals with high HLVs, often term plans
are the only option because other plans like endowment plans and unit-linked
insurance plans (IJLIPs) are either too expensive or not feasible at all.
2. Endowment Plans
The differentiating point between
endowment plans and term plans is the maturity benefit. Term plans don’t pay
the policy holder the sum assured if he survives the policy term, while
endowment plans pay out the sum assured (along with profits, if any) under both
scenarios – death and survival. Naturally, most individuals find the idea of
receiving the sum assured (along with profits) on death and survival appealing.
But this comes at a cost. Since endowment plans pay out the maturity benefit,
regardless of whether the policy holder survives the policy term or not, the
insurance company builds this into the cost of the insurance plan i.e. the
premium. This makes endowment plans more expensive than term plans.
3. Unit-Linked Insurance Plans
(ULIPs)
ULIPs are a combination of insurance
and investments. They can invest in stock/debt markets; investors have the
option to choose the debt-equity allocation. Returns from ULIPs are
market-linked and hence can be affected by the day to day fluctuations in these
markets. The premiums which you pay for ULIPs are converted into units and the
Net Asset Value (NAV) is declared regularly. Generally, ULIPs are for a term of
10-20 years with an initial lock-in period and minimum premium payment term of
5 years. The term of the policy and premium payment vary from scheme to scheme.
Like endowment plans, ULIPs can be
very expensive. However, if selected well, ULIPs can add value to your
portfolio over the long-term. Before buying any ULIP, you must understand the
various charges associated with it as these can have a significant impact on
the overall returns.
In case of an eventuality, the
beneficiary is paid either the sum assured (which generally is 5 times the
annual premium) or the fund value, whichever is higher.
Tax planning: The “assured return”
way
1. Public Provident Fund (PPF)
Investments in PPF are for a 15-Yr
period and they provide regular savings by encouraging that contributions are
made every year. You can deposit a minimum of Rs 500 and a maximum of Rs
1,50,000 in a financial year, in lump sum or in twelve installments of any
amount in multiple of rupees five. Any deposits in excess of Rs 1,50,000 in a
financial year will be refunded without interest and this amount cannot be
considered for income tax rebate. You can open a PPF A/c not only in your name
but also in the name of your spouse and children. However, please note that
aggregate deposits of upto Rs 1,50,000 p.a. are eligible for tax benefits under
Section 80C.
Currently, PPF investments earn a
return of 8.7% p.a. compounded annually. However, you should note that although
the stated returns are assured, they are not fixed. The rate of interest is
subject to change from time to time. Furthermore, withdrawals can be made only
from the seventh financial year onwards. PPF being an assured return product is
a safe investment avenue for you, if you are risk averse.
Deduction
Apart from a deduction of upto Rs
150,000 p.a. on deposits in PPF account under Section 80C, interest income from
PPF account is exempt from tax under Section 10(a)(i) of the Income Tax Act.
2. National Savings Certificate (NSC)
NSC is a time-tested tax saving
instrument with a maturity period of Five and Ten Years. Presently, the
interest is paid @ 8.50% p.a. on 5 year NSC and 8.80 % Per Annum on 10 year
NSC. Interest is Compounded Half Yearly. While the minimum investment
amount is Rs 100, there is no maximum amount. Premature withdrawals are
permitted only in specific circumstances such as death of the holder.
Deduction
Investments in NSC are eligible for a
deduction of upto Rs 150,000 p.a. under Section 80C. Furthermore, the accrued
interest which is deemed to be reinvested qualifies for deduction under Section
80C. However, the interest income is chargeable to tax in the year in which it
accrues.
3. Bank Deposits and Post Office Time
Deposits
5-Yr bank fixed deposits are eligible
for a deduction under Section 80G. The minimum amount that you can invest is Rs
100 with an upper limit of Rs 150,000 in a financial year. Currently these
deposits earn an interest in the range of 8.00% -9.50% p.a.
Post Office Time Deposits (POTDs) are
fixed deposits from the small savings segment. The minimum amount to be
invested is Rs 200 while there is no upper limit (only Rs 150,000 will be eligible
for deduction). Although you can opt for deposit of 1-Yr, 2-Yrs, 3-Yrs and
5-Yrs, only deposits with maturity of 5-Yrs are eligible for tax benefits under
Section 80C. A 5-Yr POTD earns a return of 8.5% p.a.; the interest is
calculated quarterly and paid annually. Premature withdrawals are permitted
after 6 months from the date of deposit with a penalty in the form of loss of
interest.
Deduction
The amount deposited in the 5-Yr bank
deposits and POTD are eligible for deduction under Section 80C; however
interest income on bank deposits and POTDs are chargeable to tax.
4. Senior Citizens Savings Scheme
(SCSS)
The SCSS is an effort made by the
Government of India for the empowerment and financial security of senior
citizens. So, if you are over 60 years old, you are eligible to invest in this
scheme; while if you have attained 55 years of age and have retired under a
voluntary retirement scheme, you are also eligible to enjoy the benefits of
this scheme subject to certain conditions being fulfilled.
The minimum investment in this scheme
is Rs 1,000 while the maximum amount has been restricted to Rs 15,00,000.
Again, the deduction is limited to Rs 150,000. Investments in SCSS have tenure
of 5 years and earn a return of 9.20% p.a. The interest payouts are made on a
quarterly basis every year. After one year from the date of opening the
account, premature withdrawals are permitted. If you withdraw between 1 and 2
years, 1.5% of the initial amount invested will be deducted. In case if you
withdraw after 2 years, 1.0% of the initial amount is deducted.
Deduction
Investments upto Rs 150,000 in SCSS
are entitled for a deduction under Section 80C. The interest income is charged
to tax, which is deducted at source. If you have no tax liability on the
estimated income for the financial year, you can avoid the Tax Deduction at
Source (TDS) by providing a declaration in Form 15-H or Form 15-G as
applicable.
Tax planning with “market-linked”
instruments
1. National Pension Scheme (NPS)
NPS, introduced on May 1, 2009, is
the new addition to the family of investments that qualify for deduction under
Section 80C. It is basically an investment avenue to plan for your retirement.
Contributions to this scheme are voluntary and available to individuals in the
age bracket of 18-60 years.
There are two types of accounts:
Tier-I account: In case of the Tier-I
account, the minimum investment amount is Rs 500 per contribution and Rs 6,000
per year, and you are required to make minimum 4 contributions per year. Under
this account, premature withdrawals upto a maximum of 20% of the total
investment is permitted before attainment of 60 years, however the balance 80%
of the pension wealth has to be utilized to buy a life annuity.
Tier-II account: While opening this
account you will have to make a minimum contribution of Rs 1,000. The minimum
number of contributions is 4, subject to a minimum contribution of Rs 250.
However, if you open an account in the last quarter of the financial year, you
will have to contribute only once in that financial year. You will be required
to maintain a minimum balance of Rs 2,000 at the end of the financial year. In
case you don’t maintain the minimum balance in this account and do not comply
with the number of contributions in a year, a penalty of Rs 100 will be levied.
In order to have this account, you first need to have a Tier-I account. This
account is a voluntary account and withdrawals will be permitted under this
account, without any limits.
While investing money, you have two
investment choices in NPS i.e. Active or Auto choice. Under the Active asset
class, your money will be invested in various asset classes viz. E (Equity), C
(Credit risk bearing fixed income instruments other than Government Securities)
and G (Central Government and State Government bonds); where you will have an
option to decide your asset allocation into these asset classes. In case of
Auto Choice, your money will be invested in the aforesaid asset classes in
accordance with predetermined asset allocation.
The return on your investment is not
guaranteed; rather it is market-linked. At the age of 60 years, you can exit
the scheme; but you are required to invest a minimum 40% of the fund value to
purchase a life annuity. The remaining 60% of the money can be withdrawn in
lump sum or in a phased manner upto the age of 70 years.
Deduction
Investments in NPS are eligible for
deduction upto a maximum of Rs 150,000 p.a. (part of the total 80C deduction).
However, withdrawals will be subject to tax as the scheme has the
Exempt-Exempt-Tax (EET) status.
2. Equity Linked Savings Schemes
(ELSS)
ELSS are 100% diversified equity
funds with tax benefits. A distinguishing feature of ELSS is that unlike
regular equity funds, investments in tax saving funds are subject to a
compulsory lock-in period of three years. The minimum application amount is Rs
500, with no upper limit. You can either make lump sum investments or investments
through the Systematic Investment Plan (SIP).
Deduction
Investments in ELSS are eligible for
a deduction upto Rs 150,000 p.a. under Section 80C. Long term capital gains, if
any, are exempt from tax.
Deduction Available under Other
Sections i.e. Section 80D, 80DD, 80E, 80G, 80GG, 80U
When it comes to tax savings, Section
80C lies at the top of the recall list. Every income-tax payer is familiar with
the provisions of Section 80C and the investment avenues available under it.
However, what many do not know is that there are other deductions under Section
80 which can be used to one’s advantage to further reduce your tax liability.
These deductions are related to medical insurance premium, education loan,
expenses on medical treatment, donations to various organizations and funds,
house rent paid, among others. We give below, a brief synopsis of some of the
major ones.
1. Section 80D :-The premium paid
on medical insurance policy (commonly referred to as a mediclaim policy) to
cover your spouse and you, dependent children and parents against any
unexpected medical expenses, qualifies for a deduction under Section 80D. The
maximum amount allowed annually as a deduction is Rs 15,000. If you are a
senior citizen, the maximum deduction allowed is Rs 20,000. Further, if you pay
medical insurance premium for your parents, you can claim an additional
deduction of upto Rs 15,000 under this section. For example, if you pay a
premium of Rs 15,000 for yourself and Rs 15,000 for your parents, you will be
eligible for a total deduction of Rs 30,000. If your Parents are Senior Citizen
than deduction amount can be of up to Rs. 35,0000/-
It should be noted that in order to
claim the deduction, you are required to pay the premium by cheque.
2. Section 80DD :- If you have
incurred any expenditure on the medical treatment of a handicapped ‘dependent’
with disability, the same qualifies for deduction under Section 80DD of
the Income Tax Act. The deduction is a fixed sum of Rs 50,000 p.a. if the
handicapped dependent is suffering from 40% of any disability. If the
disability is severe (i.e. 80% of any disability), then a higher deduction of
Rs 100,000 can be claimed.
The term ‘dependent’ here means your
spouse, children, parents, brothers and sisters. However, it is important to
note that the dependent person with disability should not claim any deduction
under Section 80U (please refer to point 6).
In order to claim the deduction you
will have to submit a medical certificate issued by a medical authority along
with the return of income.
3. Section 80E :- This section
definitely comes as a boon to all of you who intend taking a loan to pursue
higher education such as full time graduation and post graduation. The loan can
be taken either by you for your education or for your relative’s education. The
term ‘relative’ here includes spouse, any child or of the student of whom
individual is legal Guardian.
The entire amount of interest which
you pay on the loan during the financial year is eligible for deduction under
this section. You should avail of a loan from an approved charitable
institution or a notified financial institution.
The deduction is available for a
maximum of 8 years or till the interest is fully paid off, whichever is
earlier.
4. Section 80G:- If you have given
donations to certain specified funds, charitable institutions, approved
educational institutions, etc, the donation amount qualifies for deduction
under this section. The deductions allowed can be 50% or 100% of the donation,
subject to the stated limits as provided under this section. For example,
donations to electoral trusts are allowed 100% deduction. In order to claim
deduction under this section, you must attach a proof of payment along with
your return of income.
5. Section 80GG :-If you have paid
rent for any furnished or unfurnished accommodation occupied for the purpose of
your own residence, you can claim deduction under this section. This benefit is
available to both, self employed and salaried individuals who are not in
receipt of any House Rent Allowance (HRA). In order to be eligible for this
deduction, you, your spouse or minor child should not own any residential
accommodation in India or abroad.
The deduction available under this
section is the least of:
·
25% of the total income or,
·
Rs 2,000 per month or,
·
Excess of rent paid over 10% of total income
6. Section 80U :- Individuals suffering
from specified disability qualify for deduction under Section 80U of the Income
Tax Act. A fixed deduction of Rs 50,000 is allowed if the person is suffering
from 40% of any disability. If an individual suffers from a severe disability
(i.e. 80% of any disability), then a higher deduction of Rs 1,00,000 is
allowed.
The individual does not have to
submit any proof of medical expenses. However, he has to submit a medical
certificate issued by a medical authority along with the return of income. An
individual with disabilities such as blindness, hearing impairment, low vision,
mental retardation, etc, qualifies for deduction under this section. If you
have claimed a deduction under this section, deduction under Section 80DD
cannot be claimed.
Tax benefits and home loans
The Income Tax Act gets a little
benevolent when it comes to housing loans. It encourages you to buy your house
with a housing loan because of the tax saving benefits that come along with it.
Both, repayment of principal and payment of interest are eligible for deduction
from your total taxable income.
When it comes to repayment of
principal, you can claim a deduction upto Rs 150,000 under section 80C for
both, self occupied and rented property. The interest component of the loan
covered under section 24(b) is eligible for a deduction upto Rs 200,000 p.a.
for a self occupied property. For rented property the actual interest payable
is eligible for deduction.
Tax planning: the right way
The next step is to know which of
those investments, contributions and payments you should choose from. Your
choice of tax saving instrument should not only aim at reducing the overall tax
liability, but also compliment your investment planning process.
For example, as a part of your
retirement plan, you may be investing in equity funds and bank fixed deposits.
In such a case, your tax saving portfolio could include Equity Linked Savings
Schemes (ELSS), Public Provident Fund (PPF) and Bank Fixed Deposit. This will
ensure that your equity portfolio has a mix of ELSS and regular equity funds.
The same goes for your debt portfolio.
The underlying principle for choosing
from the various tax saving options is asset allocation, which in turn is a
function of your age, risk appetite and investment horizon (only to an extent).
To help you understand this concept,
we have prepared the model asset allocation table showing the break-up of Rs
150,000 investment under Section 80C. Model Asset Allocation Table
Age
|
Life insurance premium (Rs)
|
EPF/PPF/
Bank FD (Rs)
|
ELSS (Rs)
|
Total (Rs)
|
<30
|
30,000
|
37,500
|
82,500
|
150,000
|
30 – 40
|
30,000
|
52,500
|
67,500
|
150,000
|
41 – 50
|
30,000
|
67,500
|
52,500
|
150,000
|
51 – 55
|
30,000
|
90,000
|
30,000
|
150,000
|
The above table takes into account
the age of an individual and accordingly suggests the break-up of Rs 100,000.
If you are young and less than 30 years of age, we recommend a higher
allocation to ELSS as these are high risk investments and need time to grow. As
you are young, it makes sense to have a higher allocation to ELSS. As you grow
older, increase your allocation to secured and assured schemes like bank fixed
deposit, PPF, NSC, etc.
A closer look at the table reveals
that 20% of the available amount is allocated to payment of life insurance
premium. We believe that every individual should take a term insurance. Why
only term insurance? Simply because term insurance provides a higher risk cover
for a relatively lower premium. However, 20% allocation i.e. Rs 30,000 as a
premium amount holds good only for those individuals who take term insurance
early in their life. A premium of Rs 30,000 for a term plan can fetch you a sum
assured in the range of Rs 60-70 lakhs. This sum assured by itself may not equal
your human life value but it certainly is much higher compared to the endowment
plans. If you delay, the premium amount will only increase, leading to a higher
allocation towards the same. However, this should not act as a deterrent for
taking adequate insurance cover for yourself.
Moving on further, if you are a
salaried individual, a part of your basic salary is deducted by way of
contribution to Employer’s Provident Fund (EPF). In such a case, there is a
compulsory allocation to debt. Therefore, addition to debt by way of investment
in NSC or PPF should be done taking into account your life stage and overall
asset allocation.
At any stage in life, ensure that you
allocate some money to ELSS. Equity as an asset class has the potential to
create wealth over the long term. If you are saving for long term goals like
retirement, investments in ELSS can come handy.
We believe that the above discussion
on model asset allocation will help you in shortlisting the options that
finally make it to your portfolio. It is important to note that the model asset
allocation should not be construed as an ideal asset allocation. It is aimed at
giving you an insight into the process of choosing from a plethora of options
available.