With the beginning of the new year, investors start to weigh their options for investments to save taxes. Often, investors approach tax planning and investments solely for saving taxes, resulting in poor decisions for many.
Factors affecting the choice of tax-saving schemes
Section 80C of the Income Tax Act allows an annual deduction of up to ₹1.5 lakh from an investor's total taxable income. Section 80C of the Act offers a variety of investment options to accommodate a wide range of needs and risk tolerances. Following are the factors that you must consider before deciding to invest in tax-saving schemes:
- Corpus accumulation: Capital preservation along with wealth creation must be the primary objective of putting money into any investment opportunity rather than just tax saving.
- Investment horizon: How long do you wish to stay invested? Just because traditional tax-saving investments like PPF encourage you to invest for 15 years does not mean that you must limit your investments to this tenure only. It helps if you continue your investments for 20-25 years, which will not only relieve you of the tax burden but also ensure the accumulation of the much-desired corpus over the period.
- Potential returns: Focus on returns than just saving on taxes. This will help you decide between market-linked and non-market tax-saving investments under Section 80C.
- Risk profile: Your age and financial situation will determine your risk tolerance. You must talk to a professional financial advisor if you need help understanding your risk tolerance. Your risk profile may vary from low to high depending on your age, experience and other factors.
- Liquidity: If necessary, how quickly can you convert your investments into cash? To claim tax benefits, all 80C investments require you to stay invested for a minimum period of time, but different schemes have different liquidity profiles.
- Taxation of maturity proceeds: How will the proceeds of your 80C investments be taxed upon maturity or redemption?
Choosing between Section 80C investment schemes
Under the various schemes available under Section 80C, one may choose between the following options depending on their monetary goals, financial viability and ability to invest.
- Schemes which are not market-linked: Non-market schemes u/s 80C include Employee Provident Fund (EPF), Voluntary Provident Fund (VPF), Public Provident Fund (PPF), National Savings Certificates (NSCs), five-year tax saver bank FDs, and traditional life insurance plans (e.g. endowment plans, money back plans). The majority of non-market-linked schemes guarantee a fixed rate of interest for a specified time period. The interest rates on small savings schemes are reviewed by the government on a quarterly basis. Traditional life insurance plans also include guaranteed additions based on the policy term, as well as fixed income features such as payment of the sum assured on maturity or money back from time to time. Non-market-linked schemes provide both capital safety and fixed-income returns.
- Market-linked schemes: The market-linked schemes under section 80C are mutual funds' Equity Linked Savings Schemes (ELSS) and Unit Linked Insurance Plans (ULIPs). These schemes make investments in financial market securities such as stocks. Their returns are linked to market returns and are vulnerable to market risks. These investments offer no guarantee of capital safety.
Evaluation of tax-saving schemes based on factors like investment objective, investment tenure and potential returns will help you choose the most suitable one among the available tax-saver options, thus, allowing you to choose the one that is in sync with your financial goals.