With the beginning of tax season once again we are scrambling to invest money in tax saving schemes to avail maximum deduction possible for us, especially the salaried individuals. There is a catch though; as the time runs short we are prone to make decisions that may be dangerous or not so beneficial from the long term perspective.
Saving or spending to save taxes can be a tricky job due to reasons provided below:
- Investment may require you to hold on to it for a certain period of time to make the exemption permanent.
- Requires a huge outflow or a decision of a lifetime
In the normal times all the taxpayers should plan in advance, but just in case if you have not or are falling short this article shall provide much needed assistance in making the right choice. This article is dedicated to all such individuals and advisors who are looking forward to invest for
- For the maximum tax exemption possible and
- The best possible long term solution
In our decision making process for the choice of best investment options for saving tax, we will be looking at the following factors:
- Return on Investment
- Flexibility of Investments
- Taxability of Dividends/Capital Gains &
- Liquidity
Available Deductions
First of all let us look at the available limits of deductions that can be claimed from gross total income for the current assessment year. With the increase of deductions limits for Assessment Year 2015-16 following deductions are applicable for individual taxpayers:
Deductions from Gross Total Income: Following deductions can be claimed against the Gross taxable income for the Assessment Year 2015-16:
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Table 1: Deductions from Gross Income
Additional Deductions can be claimed under the following sections:
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Table 2: Deduction Available to Homeowners
Making the Most of the Deductions u/s 80C
Deductible Investments & Expenses
Deductions Under section 80C amount to a total of Rs. 150,000 and include specified investments and expenses that can be made to claim this deduction in current assessment year. The choice of instrument for a person may vary depending on the needs of the family as we will see in the table 3 below.
The investments can be classified in multiple ways, for example:
- Debt investments or fixed income products,
- Market Linked Investments or Equity Products and
- Expenditures incurred
From the point of view of ease of choice another classification can be as follows:
- Retirement Products
- Fixed income investments
- Equity Products
- Life Insurance plans & Expenditures
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Table 3: Investments & other venues for Deduction u/s 80C
Period of Holding for Investments
For the deposits and investments made for 80C deductions it is necessary to follow the minimum holding period rule in order to avail the deduction without having to reverse it in the following years. Provided below are the time limits that applies to investments u/s 80C:
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Table 4: Minimum Holding Period for Various Instruments u/s 80C
The result of not adhering to the time limits can be of reversal of deductions, which will be assumed as income of the year in which asset is terminated. Therefore, before selecting the avenue make sure that you are ready lock in the money for the minimum holding period.
Other than these limits which are required for the purpose of taxation there are other instruments, which lock in the money for long periods of time, such as:
- Public Provident Fund (PPF)
- New Pension Scheme (NPS)
These schemes have been popular and are an excellent venue for saving for retirement, but that also means that the money is locked up for a long time. For example: PPF allows a loan till five years and a 25% of balance as withdrawal from 6th year, whereas NPS Tier I account (which is currently the only available option) holds on to the investments till the investor reaches 60, only other instances of withdrawal being critical illness and death.
Return on Investments
Returns are an important consideration when it comes to investments especially while you are young and have potential for high risk. For long period of holding equity schemes certainly perform better than fixed income instruments. Given below is a comparison of returns on various instruments over time:
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Table 5: Post tax Returns on Various Investment options
* Post tax returns
** Linked to secondary debt market yield
Apart from the required minimum holding period for different investments to avoid reversal of deduction, holding period also plays an important role when it comes to enjoying the returns from these instruments. For example:
ELSS being an equity scheme may require a longer holding period even after initial three years to generate good returns going up to five years or more, whereas, ULIP may take more than 10 years to come to terms with other similar investments.
Another factor that produces a dampening effect on your return is the cost of investment. Especially when you are looking for equity related investments; i.e. NPS, ELSS, ULIPs and some debt based investments like Pension Plans. The table below summarizes the cost effectiveness of the various investments discussed above:
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Table 6: Expense Ratios on Various Investments
It turns out that the NPS comes out as the least expensive of them all and ranks highest when we look at the portfolio and exposure to equity investments. Also the Employer’s contribution to this scheme is not taxable when it is made.
Further exemptions in many investments especially the retirement schemes for salaried taxpayers such as NPS and EPF contribution will be limited to a percentage of salary only; i.e. NPS allows tax exempt contributions up to 10% of the salary whereas in EPF it can go up to 20% of salary.
Deductible Expenses
Apart from all the investment options there for claiming the exemption of Rs. 150,000 there are certain common expenses as well allowed as deduction under section 80C. Especially for taxpayers with school going children, tuition expenses on their education can be claimed under 80C for expenses.
The principal repayments on home loans also qualify for deduction u/s 80C, and mostly can capture a large chunk of the deduction if home loan is in the final years when principal repayment actually exceeds the interest paid throughout the year.
Claiming Medical Expenditure (Sec 80D, 80DD & 80DDB)
Income tax code in our country also provides for any medical expenditure incurred for precautionary or treatment purpose, including medical insurance premiums. Easiest and best of them are the deduction allowed for medical insurance premium paid in the P.Y. 2014-15:
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Table 7: Medical Deduction u/s 80D
Therefore, while purchasing health insurance policy it is advisable that you purchase adequate amount of health cover, not just for your family but if required for parents as well. That should not just keep your parents’ healthcare costs down but also provide individual taxpayer additional exemption of up to Rs. 50,000 (Below 60 family and senior citizen parents).
Maximum Deduction
Further additional money spend on healthcare of a dependent family member for any of the specified deceases can be exempt up to Rs. 40,000 for members who are below 65 yrs. of age and Rs. 60,000 if above 65 yrs.
Expenditure on treatment and rehabilitation of a dependent family member who is suffering from a disability allows for Rs. 50,000 in deductions irrespective of actual expenditure. In case of severe disability it becomes Rs. 100,000.
Therefore, for a taxpayer maintaining dependent senior citizen parents and a disabled dependent relative the exemption can go up to Rs. 2,10,000 including medical insurance premiums.
Homebuyers’ Delight (Sec 80C, 80EE & Sec 24)
Well it seems in our tax system homebuyers are favored subjects for deductions and exemptions. Homebuyers and owners purchasing property on loan can claim interest and principal repayments in deductions. While principal repayments are deductible u/s 80C up to Rs. 150,000 for current assessment year (2015-16), interest repaid can be claimed u/s 80EE and Sec. 24(b).
Deduction of Interest u/s 24(b)
Section 24(b) allows for deduction of interest repaid on loans for:
- Purchase or
- Construction of residential property
The maximum amount exempt will depend on whether the house so purchased or constructed is:
- Self-Occupied [or]
- Let out for rental income
If the house is self-occupied as in the case of most ‘first time buyers’ the maximum deduction available is limited to Rs. 200,000 on interest repaid in the Previous Year 2014-15. In case of let out property this can be unlimited, and is calculated under the head ‘Income from house property’.
How do you benefit in case of let out property is that, interest paid reduces your income from the property. If interest paid is more than taxable rent received, taxpayer ends up incurring a ‘loss on house property’ which is adjustable with any other income heads.
For example:
Rajat a salaried taxpayer has the following incomes:
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He is also repaying a loan on the purchase of this property under which he paid Rs. 381,140 as interest and Rs. 63,541 as principal on this loan in the previous year. His income from house property calculation can be as follows:
Let out Property:
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If the property is let out it, it has reduced the Rajat’s total income and brought it down to a great extent and gives him a tax saving of approximately Rs. 63,000.
If property is self-occupied:
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Even when the property is self-occupied tax saved is in tune of Rs. 60,000 as Rajat falls into the 30% tax bracket. Also this will be further reduced as principal repaid will also be deducted from his gross income.
Deduction of Interest u/s 80(EE)
It is one of the rarest of the rare exemptions as it is available only for A.Y. 2014-15 and 2015-16, provides for additional deductions for first time home buyers. There are few conditions for investment to qualify for deduction under this section:
- The property value shall not be more than Rs. 40 lakh
- The Loan amount is Rs. 25 lakh or less
- The house is the first house purchased by taxpayer
- Loan is from a Financial Institution (i.e. Banks etc.) or Housing Finance Company
- The taxpayer does not own any other house property
A total of Rs. 100,000 is provided as deduction, which can be spread over the two assessment years mentioned above. Therefore, if you have claimed any deduction in A.Y. 2014-15 under this section you may claim only the remaining balance as deduction in the current A.Y.
Deducting the Interest Paid on Education Loan (80E)
Interest paid on an education loan taken to fund a full time higher education is allowed for exemption in the year in which it is paid. Loan can be taken for:
- Self & Spouse
- Children or
- Student under legal guardianship of taxpayer
Provided the loan is from a recognized charitable institution or financial institutions, and the interest is paid out of taxable income. Meaning it can only be applied up to the amount of taxable income.
Conclusion
For most of us 80C remains the area of concern as decisions may be required to be taken almost every year. For this reason getting back to the ranking of available investment options u/s 80C under the parameters decided in the beginning will be a good idea:
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Table 8: Investment avenues ranked for different features on a scale of 1 to 5 (5 being the best)
The rankings have been done for the average taxpayer who is not a senior citizen or past the retirement age. Crossing the threshold of 60 may change the preferences and risk appetite to allow choice of equity linked products, thus it is advisable that for your individual preference and best choice contact your wealth manager/financial planner.
Note: Products are ranked on the basis of their relative performance under the head in the years so far and past performance does not guarantee the future performance of the products.