The last quarter of the fiscal year is approaching, and your employer should have sent out reminders to provide details of your tax savings investments. Starting this year, you can choose lower tax rates by forgoing Chapter VI-A deductions (including Section 80C). However, those of you who stick to the old system should now look for tax saving investment options.
With the shortest lock-in period among Section 80c tax savings investments, Equity Linked Savings Plans (ELSS) may be the preferred option for most. If you’re considering year-end investments in ELSS, here’s what you should keep in mind.
#1 Stick to goals
Just as with any investment decision, it would be wise to align your investment with your financial goals. Often, tax savings should be treated as a plus and not misclassified as an investment objective.
If you have already exceeded the required limit on equity investments, considering ELSS for tax savings, again, may not be good for your portfolio, given the need to allocate assets wisely and avoid concentration risk. .
Agreed, annual savings (in taxable income) amounting to ₹ 1.5 lakh under Section 80 C of Income Tax Act may be certainly significant. However, there are plenty of options to make up for that amount, every year. 5-year tax savings deposits made by banks, 5-year post office deposits, a National Savings Certificate (NSC) or Seniors Savings Scheme (SCSS) – with a 5-year insurance period – or contributions to a Public Provident Fund (PPF) that Must be deposited into the account for 15 years May not be your preferred choice due to the longer mandatory holding period. However, one can still make up the ₹ 1.5-lakh discount through other methods.
For salaried people, employee contributions to an Employees Provident Fund (EPF) may already cover most of the Section 80c deduction. Besides some expenses such as life insurance premiums paid to self, spouse and/or children, tuition fees (excluding donations or development fees) paid for children’s education (up to a maximum of two children can be claimed), and principal repayment of the loan in your home the loan is eligible Also for a deduction under Section 80c.
Only after adding the above-mentioned qualifying deductions, and if there is any shortfall in the said limit of Rs 1.5 lakh each year, one should consider any tax saving investment.
#2 Understand the product
Within eligible tax-saving investments under Section 80c, while a shorter ELSS lock-in may be tempting, keep in mind that the holding period is a mandatory period. That is, while one can pay a penalty and withdraw before the stipulated holding period, as in the case of investments in SCSS (after deducting 1-1.5 percent of the amount invested), or by waiving 2 percent interest on the 5 term deposit years offered by the Post Office or Banks, no such provision is available for ELSS investments. Early withdrawal of investments in EPF or PPF is also allowed subject to conditions, while one can close an NSC investment prematurely only on the death of the depositor.
Besides, ELSS are basically mutual funds that invest mostly in stock markets. Hence returns from ELSS can be highly volatile versus fixed returns from tax savings deposits, NSC or SCSS.
While EPF or PPF returns are not guaranteed (at the time of investment either), they can be estimated with greater certainty when compared to ELSS returns.
Apart from that, while the investment helps in saving tax, ELSS returns are taxable. While dividends from the fund are taxed at your tranche rates, long-term capital gains (as they can only be sold after 3 years) are taxed at the time of redemption at 10 percent.
However, Total Long Term Capital Gains (LTCG) in any year is exempt up to Rs 1 lakh. Given the returns one can generate, other investment options with exempt-exempt (EEE) status may be beneficial.
For example, investments in a Sukanya Samriddhi, EPF (subject to conditions) or PPF at all three stages are tax-exempt – on investments, average returns and upon redemption. Investment in unit-linked insurance plans, which amounts to ₹ 2.5 lakh in any year, also enjoys EEE tax status.
If you believe that ELSS may best fit your savings goals depending on your risk appetite, it is a good idea to choose a growth option.
This is because unlike the dividend option, the growth option helps you benefit from reinvesting your returns and making the most of your tax savings, if your income is taxed at the highest bracket rates.
#3 Plan ahead
If ELSS is the best option for you, it is advisable to plan your investments in advance. Given the massive valuations that local stocks are currently trading at, a lump sum may not be the right way to approach your ELSS investments. While starting a SIP program at the beginning of the year would ideally be the best way to do this, one can still hold ELSS investments over the remaining four months (December 2021 to March 2022), this year. This way you can protect your investments from market fluctuations.
From the coming years onwards, plan in advance and come up with how much you will need to invest in ELSS to make up for the discount limit of Rs 1.5 lakh and choose the monthly SIP route. Depending on the fund’s track record, try to stick to the same group of ELSS funds rather than investing in a new scheme each year. This is because while diversification has its own advantages, too much of anything can be detrimental to your business portfolio.