Tax-saving instruments to include in your investment portfolio

For a big chunk of the populace earning a monthly income, tax planning is usually an activity that is pushed to the back burner until the tax season kicks in. But when you near the end of the financial year, there would be so little time and so many options that you may not take the right investment decisions in haste.

The most recommended strategy would be to start investing during the first quarter of the financial year. This way, you will have enough time to plan your investments and get maximum tax savings.

What to look out for when investing

When you invest in a financial instrument that yields returns, one of the most important factors to consider is whether the income earned is taxable. In case this is so, a portion of the money you make over a period of time will be deducted as tax, hence eating into your returns. Consider a scenario in which you have invested in an instrument like National Savings Certificate (NSC). When you receive the interest from the investment, this amount is added to your income from other sources. This implies that the interest amount from NSC is liable to be taxed like your ordinary income.

It should be noted that the NSC scheme enables you to save on tax as well. However, the interest you earn is a tax liability for each financial year till the end of the tenure. So, the post-tax return you effectively earn from such an instrument could be much lesser than you had initially estimated. Senior Citizen Savings Scheme (SCSS) and 5-year time deposits with post offices and banks are also liable to the same format of taxation. So, it is important that you look out for investment avenues that not only help you save tax but also provide you tax-free income.

Tax-saving instruments to choose from

The following investment options offer you considerable tax savings. In case you intend to maximise your returns, pay close attention to the investment instruments that provide tax-free income:

1.Unit Linked Insurance Plan (ULIP) – This is a type of life insurance policy that provides the policyholder dual benefits of protection and savings. A ULIP offers financial protection to the life of the policyholder and also channels his/her investments into market-liked debt and equity instruments with varying risk profiles. This, effectively, enables the policyholder to meet his/her long-term financial goals. In most ULIPs, the insurer provides varying fund options from which the investor can choose. The duration of a ULIP is usually between 15 and 20 years, but the lock-in period for the fund value is 5 years. This effectively means that the policyholder will be unable to withdraw the fund value before the completion of 5 policy years.

When the fund value is finally withdrawn, either at the end of 5 years or after the policy matures, it will be available as a tax-free return to the policyholder. The tax exemption is offered under Section 80C and Section 10(10D) of the Income Tax Act. The policyholder also receives the flexibility to switch between funds while staying invested in the plan.

ULIPs are ideal for people who are not disciplined to make market-linked investments independently. In case you are comfortable in managing investments in ELSS on your own, you can opt for a pure term insurance plan to serve the purpose.

2.Employees’ Provident Fund (EPF) – EPF is an investment channel that helps a salaried person save tax through involuntary savings. The investment also accumulates a tax-free corpus, making it one of the most popular investment avenues. The employee contributes 12% of his/her basic salary towards the EPF account every month. An equal amount is contributed by the employer, and a part of this amount accumulates in the EPF.

The employee’s contribution to the EPF corpus is eligible for tax benefits under Section 80C of the Income Tax Act, with an upper limit of Rs.1.5 lakh. It should be noted that the employer’s share is not tax-free. The contributions of the employee and employer are eligible for tax-free interest as well.

The employee has the flexibility to increase his/her contributions to the corpus. When this is done, the account becomes a voluntary provident fund (VPF). VPF is a part of EPF and the rules surrounding it are identical to that of EPF. The interest accumulated in the EPF/VPF account is exempt from tax, provided that the individual stays employed for a minimum of 5 continuous years.

3.Health insurance – This is a valuable investment tool in the financial arsenal of a salaried individual who has dependents. Apart from providing you financial assistance to safeguard you from unexpected medical fees, a suitable health insurance plan provides you tax deductions under Section 80D of the Income Tax Act. The upper limit on this exemption is Rs.15,000. This goes up to Rs.20,000 for senior citizens. You should note that Section 80D is not applicable for group health insurance coverage offered by employers to employees.

Suppose you have enhanced your health insurance plan with a personal accident rider. The lump sum that you are eligible to receive as payout from the rider in the event of an accidental disability is not taxable.

Apart from the above-mentioned investment channels, you should be aware of the fact that investing in property helps you save on tax to a great extent. In line with this, taking a home loan to purchase your dream home would be the right decision. So, stay alert and focus on making prudent investments early in the year for maximum benefits.

(This content has not been created by the editorial team.)