Many taxpayers including your sister who filed their income tax returns (ITRs) by July 31 this year regretted their inability to refrain from investing in tax-saving instruments last year. Many of them had bought insurance policies and endowment plans in a bid to save taxes on the insurance premiums paid not realising how their decision interfered with their financial growth. Still, many others invested in tax-saving fixed deposits and other traditional savings opportunities, thus, allowing their money to grow at a very slow pace.
However, if you are looking to gift your sister tax-saving instruments that help her to create wealth too, putting money in equity-linked savings schemes (ELSS) can help. This Raksha Bandhan, go innovative. While your sister ties on your wrist the much-circulated and recycled dazzling Rakhi this year, gift her an ELSS fund that will secure her finances for the future while enabling her to save on taxes.
Not many know how putting money in ELSS mutual funds helps investors who are seeking tax savings and enduring gains. These funds extend an array of advantages, including:
Tax deduction under Section 80C of the Income Tax Act: Investors can claim a tax deduction of up to ₹1.5 lakh and save up to ₹46,800 a year in taxes by investing in ELSS funds.
Potential for substantial returns: ELSS funds channel investments into the stock market, offering the potential for commendable returns over an extended timeframe.
Brief lock-in period: ELSS funds entail a mere three-year lock-in period, which is briefer compared to other tax-saving investments like the Public Provident Fund (PPF) and National Savings Certificates (NSCs).
Versatility: Participation in ELSS funds is achievable through a systematic investment plan (SIP), granting the option to invest a fixed sum each month. This feature renders investing convenient, even for individuals with modest available funds.
More about ELSS funds
There is more to investing in ELSS funds than just considering them for tax-saving measures. Here are some additional points to consider regarding ELSS funds.
No upper investment limit: There is no maximum threshold for investing in ELSS. However, the minimum investment requirement varies among different fund houses. Some fund houses stipulate a minimum investment of ₹500, while others set it at ₹1,000.
Potential for outpacing inflation: ELSS funds channel investments into the stock market, presenting the potential to yield returns that surpass inflation rates. This implies that your investment has the ability to grow in real value, even when considering inflation.
Twin advantages of tax deductions and wealth generation: ELSS funds deliver the combined advantages of tax deductions and wealth accumulation. You can claim a tax deduction of up to ₹1.5 lakh for investing in ELSS. Moreover, the returns from ELSS funds contribute to long-term wealth augmentation. The bulk of asset allocation in ELSS mutual funds (constituting 65 per cent of the investment portfolio) is directed towards equities and equity-linked securities, encompassing listed shares. Additionally, there might be a certain degree of involvement with fixed-income securities.
Enabling wealth creation through ELSS funds
A look at the performance of ELSS funds reveals how many such funds have helped to create investors’ wealth over the period. Saying this, we all know that the first step to accumulating a decent corpus takes time. For example, some ELSS funds have helped investors to grow their earnings by almost two times in three to four years Over the period as markets move up and down in crests and troughs, these ELSS funds have yielded a decent 15-20 per cent returns over a decade, thus, allowing ample scope for wealth creation.
The following table illustrates how some ELSS funds have helped investors refine their wealth creation process in a few years as opposed to most other financial instruments that take more than a decade just to double the money.
Assuming that you had invested ₹10,000 every month for five years or continued to invest for a decade, you would have accumulated a decent corpus.
Name of the Fund
Quant Tax Plan
Mirae Asset Tax Saver Fund
HDFC Tax Saver Fund
Sundaram Tax Savings Fund
Bandhan Tax Advantage (ELSS) Fund
Tax benefits of putting money in ELSS
Just because investing in ELSS funds helps to save on taxes, it surely does not hint at the similarity of benefits. The consideration of taxation on redemption or maturity funds holds significance in the process of making investment choices. Diverse investment options undergo distinct tax treatments, underscoring the need to grasp the consequences associated with each choice before committing to an investment.
You cannot appreciate the tax benefits from ELSS investments unless you compare them with schemes touting to offer similar benefits. Below is a concise summary outlining the taxation aspects of several well-known tax-saving investment alternatives that will help you compare and decide your next investment(s) accordingly.
Employee Provident Fund
The Employee Provident Fund (EPF), a retirement savings scheme commonly provided by Indian employers, holds tax benefits. Contributions to the EPF by both the employee and the employer are eligible for tax deductions under Section 80C of the Income Tax Act. Moreover, the maturity proceeds of the EPF are exempt from taxation, given specific conditions are met.
Nonetheless, as of April 1, 2022, changes to EPF tax regulations have been implemented. The following are the main modifications:
- Interest earned on EPF contributions up to ₹2.5 lakh per annum is now subject to taxation for the employee.
- The threshold for tax-free interest on EPF contributions is raised to ₹5 lakh if the employer doesn't contribute to the EPF.
- A 10 per cent tax deducted at source (TDS) is applicable on EPF withdrawals when the withdrawal amount exceeds ₹50,000 and occurs before completing five years of service.
The TDS rate on the taxable portion of EPF withdrawals in cases without a PAN is reduced from 30% to 20 per cent.
Voluntary Provident Fund
The Voluntary Provident Fund (VPF) stands as an elective retirement savings scheme extensively available through Indian employers Employee-contributed sums to the VPF qualify for tax deductions under Section 80C of the Income Tax Act, up to a ceiling of ₹1.5 lakhs within a fiscal year. Moreover, interest accrued on VPF contributions remains exempt from taxation, contingent on specific criteria.
The prerequisites for interest on VPF contributions to remain untaxed are outlined as follows:
- The cumulative contribution to both EPF and VPF during a financial year must not surpass ₹2.5 lakhs.
- If the combined contribution to EPF and VPF exceeds ₹2.5 lakhs, the interest earned on the excess contribution becomes subject to taxation.
- Taxation of the interest income will be dictated by the employee's applicable income tax slab.
To illustrate, consider an instance where an employee allocates ₹3 lakhs to EPF and VPF during a fiscal year. In this scenario, the interest amassed on the surplus contribution of ₹50,000 will be subject to taxation. The precise tax liability on the accrued interest hinges on the income tax slab applicable to the employee.
Public Provident Fund
The Public Provident Fund (PPF) constitutes a prolonged savings scheme administered by the Government of India. Contributions channeled into the PPF offer tax deductions according to Section 80C of the Income Tax Act, permitting a maximum of ₹1.5 lakhs annually. The PPF also bestows tax-exempt status on the interest accrued.
With a 15-year lock-in duration, the PPF entails the possibility of partial withdrawals post the conclusion of the 7th fiscal year. Notably, the maturity gains stemming from the PPF also bear no tax liability.
Key characteristics of the PPF encompass:
- A cap of ₹1.5 lakhs for annual contributions.
- Government-decided interest rates compounded on an annual basis.
- A lock-in span of 15 years, while partial withdrawals become viable after the 7th fiscal year.
Complete exemption from tax obligations on maturity proceeds.
Five-year tax saver bank FDs
The interest accrued from a five-year tax-saving bank Fixed Deposit (FD) enjoys tax exemption under Section 80C of the Income Tax Act, within the annual limit of ₹1.5 lakhs. However, should the FD be prematurely withdrawn, the interest earned becomes subject to taxation in the year of maturity.
Salient attributes of a five-year tax-saving bank FD encompass:
- An upper investment ceiling of ₹1.5 lakhs within a fiscal year.
- A fixed interest rate on the FD isdetermined by the bank, compounded on an annual basis.
- A 5-year mandatory lock-in period.
- Tax-free interest earnings under Section 80C of the Income Tax Act, capped at ₹1.5 lakhs within a fiscal year.
In the event of premature FD withdrawal prior to the five-year lock-in, the accrued interest becomes taxable during the year of maturity.
National Savings Certificates
The interest accumulated from National Savings Certificates (NSC) is not exempt from taxation. However, the interest earned is treated as reinvested, making it eligible for a tax deduction under Section 80C of the Income Tax Act. This implies that the interest doesn't attract annual taxation but is only taxed upon maturity or withdrawal.
The fundamental aspects of NSC are outlined as follows:
- An upper investment threshold of ₹1.5 lakhs in a fiscal year.
- The government establishes the fixed interest rate for NSC, with compounding on an annual basis.
- The stipulated lock-in period spans five years
- Interest earnings are considered reinvested, entitling them to a tax deduction under Section 80C of the Income Tax Act.
Taxation of NSC interest occurs exclusively during maturity or withdrawal. The tax obligation hinges on the investor's applicable income tax bracket.
Life insurance maturity proceeds
The culmination benefits from a life insurance policy remain untaxed, provided the premium remains below 10 per cent of the sum assured for policies issued after April 1, 2012. For policies issued before that date, the premium must not exceed 20 per cent of the sum assured to evade taxation.
In the end, you must encourage your sister to invest her money in an opportunity in sync with her risk profile and her understanding of how her future earnings from the market need not mirror the fund’s past returns, thus, necessitating her to show patience and rely on persistent and continued investing for optimal yields for a financially secure future.