It is the last quarter of the financial year, and the tax planning season is in full swing. Most people get a reminder from their finance department to submit investment proofs. You must also be scouting for financial products to save tax. However, when you choose a financial product for investment, tax benefit at the time of investment is just one aspect of it. You need to consider other features of the product to assess whether it fits your requirement and then accordingly take an investment call. Let us look at some of these features.
1) Tax Treatment at the Time of Maturity/Redemption
Some products give you income tax benefits under Section 80C, 80CCD, etc. at the time of investment. It is equally important to understand the tax treatment at the time of redemption/maturity.
For example, let us assume that a 5-year tax-saving fixed deposit is giving an interest of 7 percent p.a. However, the interest earned on a fixed deposit is fully taxable (except for relief up to Rs. 50,000 for senior citizens under Section 80TTB). So, if you are a young or middle-aged individual falling in the 30 percent income tax bracket, after paying tax, the 7 percent p.a. interest will get reduced to 4.9 percent p.a. Let us assume that the Public Provident Fund (PPF) also pays 7 percent p.a. However, the maturity proceeds of a PPF are tax-free.
So, based on tax treatment at the time of maturity, if we compare a 5-year tax-saving fixed deposit with PPF (assuming both are giving the same interest rate), PPF turns out to be a better investment product.
Similarly, check the tax treatment for other financial products on maturity/redemption. For example, the death benefit on a life insurance policy is tax-free in the hands of the nominee/legal heir. In the case of ELSS, the first Rs. 1 lakh long-term capital gain (LTCG) is exempt in a financial year. The incremental LTCG is subject to a 10 percent tax.
2) Risk Involved
When choosing an investment product, check whether the risk involved matches your risk appetite. For example, an ELSS scheme has to invest a minimum of 80 percent of its total assets in equity and equity-related instruments. Equities are volatile in the short term. They are suited for investors with an aggressive risk profile. So, if you are a conservative investor, ELSS is not for you. You need to look at fixed-income products, such as Public Provident Fund (PPF), tax-saving fixed deposits, National Savings Certificate (NSC), etc.
3) Expected Rate of Return
If your expected rate of return from financial products is 10 percent CAGR or higher, you will have to consider investing in ELSS or NPS (choose equity asset class). If you choose to invest in debt products such as PPF, tax-saving fixed deposit, NSC, etc., you will have to be content with single-digit returns. The returns from debt products may or may not be enough to reach your financial goals.
It is recommended that you follow asset allocation with appropriate allocation to domestic equity, international equity, debt, gold, etc. It will help you diversify your investment portfolio and earn optimum risk-adjusted returns.
4) Investment Time Horizon
All tax-saving products have a specific investment period, post which they can be redeemed or closed.
a) The ELSS has the lowest lock-in period of 3 years. An investor has the option to continue beyond the 3 years or redeem the units.
b) The NSC and tax-saving fixed deposit have a tenure of 5 years. Post maturity, the investor can withdraw the money or reinvest.
c) The PPF has a tenure of 15 years. Post maturity, the investor can extend the tenure in a block of 5 years at a time.
d) The tenure of the NPS is till retirement (60 years). On maturity, the investor can withdraw up to a specified percentage of the accumulated amount (commutation) and buy an annuity with the remaining amount.
When choosing an investment product for tax saving, keep in mind the timeframe for your financial goals. If your financial goal is 5 years away, you may consider a 5-year tax-saving fixed deposit, NSC, etc. Going for investment products with a higher tenure, such as PPF, NPS, etc. will be a mismatch with your 5-year financial goal.
In the above point, we discussed how the tenure of the financial product chosen for tax saving should match the investment time horizon for your financial goals. You can classify your financial goals into short (less than 3 years), medium (3 to 7 years), and long (beyond 7 years) goals and choose the tenure of investment products accordingly.
However, sometimes you may have some urgent requirement to make a withdrawal from your long-term investment. In such cases, please be informed that there are short-term solutions that can come to your rescue. For example:
a) After 3 years, you can make partial or full withdrawal from ELSS as per your requirement. You can pause fresh investments at any time.
b) You can take a loan against your NSC by offering the certificate as collateral.
c) The PPF allows you to take a loan or make a partial withdrawal after completing a specified number of years.
d) You can make a partial withdrawal from NPS after completing a specified number of years. The partial withdrawal can be up to a certain percentage of the contributions made. Lastly, the partial withdrawal money can be used only for specified purposes. Some of these purposes include higher education and marriage of children, purchase or construction of a house, treatment of specified illnesses, etc.
However, with a tax-saving fixed deposit, you can neither make a partial withdrawal nor take a loan against it. So, while choosing an investment product for tax saving, check the liquidity options.
6) Minimum and Maximum Investment Amounts
When selecting a financial product for tax saving, check the minimum and maximum investment amounts. For most financial products, the minimum investment amount usually starts from Rs. 500 – 1,000. It is affordable to most people across various income categories.
In the case of PPF, the maximum investment allowed in a financial year is Rs. 1,50,000. For investment products like ELSS, NSC, life insurance, etc., there is no limit on the maximum amount that you can invest in a financial year. However, the maximum deduction that can be availed in a financial year is limited to Rs. 1,50,000 under Section 80C. For NPS, the maximum deduction is specified under Section 80CCD.
7) Ease of Investing
Apart from the investment limit, you should also consider the ease of investing. For example, with the ELSS, you can go with the systematic investment plan (SIP) route. The specified amount will be auto-debited from your bank account at the specified frequency (weekly, monthly, etc.), and your mutual fund account will be credited with the equivalent units. With life insurance premiums also, you can go with the auto-debit option. The auto-debit frequency can be monthly, quarterly, half-yearly, or yearly.
The NSC and tax-saving fixed deposits are lumpsum investment options. Every time you need to invest additional money, you have to purchase a fresh NSC certificate or make a new fixed deposit. With the PPF, for every additional investment, you have to initiate a fresh transaction, either online or visit the bank/post office.
Tax Saving at the Time of Investing is a Good Starting Point
To conclude, when choosing to invest in a financial product, look beyond tax saving at the time of investment. Although tax saving is a good starting point, consider the other features of the financial product. Match all the features with your needs, and accordingly take the investment decision.
Gopal Gidwani is a freelance personal finance content writer with 15+ years of experience. He can be reached at LinkedIn