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Investing to save tax – Smart Money News

For the salaried Indian, income tax saving is a stress-inducing facet. The entire rigmarole of worrying about how much to save to reduce income tax, and where to save and invest to save tax, involves some of the common pain points. With several tax-saving options, the choice could be daunting as much for a new taxpayer as for a seasoned one. Moreover, tax laws often change and one could move from a lower to a higher tax bracket, resulting in a change in the applicable income tax rate.

For the salaried Indian, income tax saving is a stress-inducing facet. The entire rigmarole of worrying about how much to save to reduce income tax, and where to save and invest to save tax, involves some of the common pain points. With several tax-saving options, the choice could be daunting as much for a new taxpayer as for a seasoned one. Moreover, tax laws often change and one could move from a lower to a higher tax bracket, resulting in a change in the applicable income tax rate.

In fact, today, we have two income tax structures—one wherein you don’t need to worry about tax savings, as in this option you pay an effective lower income tax across six tax slabs without claiming any income tax savings; and the other is the older tax regime, under which you can claim tax savings on a set of defined savings and investment instruments. The latter tax-saving option is popular for the numerous tax-saving avenues it offers and because it has been in existence for a much longer time. For many Indians, tax saving is the only source of a meaningful savings and investment plan.

There is a lot to choose from towards tax savings under Section 80C with its overall Rs 1.5 lakh limit. So, irrespective of the tax slab that one falls under, the maximum tax savings one could claim as deduction is Rs 1.5 lakh. The financial instruments vary from those with savings orientation to those in which the performance of the instrument is market-linked. Then, there are select expenses that also could be claimed towards tax savings (see Tax Saving Options under Section 80C). With so much choice, it could be tough to select instruments that could work efficiently to meet your financial goals.

INVESTING AND TAX SAVINGS

Investing in products that could also double as tax-saving instruments could work to your advantage. For those new to investing, these could also be their initiation to invest in market-linked products. Two investing instruments stand out—ELSS and NPS—both having features that could work for most taxpayers. NPS is long-term retirement savings, open to every Indian (resident and non-resident) and introduced by the government of India, and is structured to have two accounts—Tier 1 and Tier 2.

Tier 1 is mandatory and meant for retirement savings for employees of the government sector and the private sector as well as those who are self-employed. Tier 2 is for general investment, which doesn’t offer any tax savings. One can invest in NPS from age 18 up to age 65, with minimum contribution to Tier 1 being at least Rs 500 per transaction and at least Rs 6,000 per year. One can join the NPS as late as when they are 60 years old and continue to contribute until they are 70 years old.

NPS is structured as a mutual fund where investments are converted to units, with investments spread across different asset classes. The available asset classes that NPS invests in include equity, corporate debt, government securities and AIF (Alternate Investment Funds). However, one can invest a maximum of 75 per cent of the total portfolio into equities and maximum allocation to the alternate asset will be limited to 5 per cent. You also have the option to choose the automatic lifecycle-based portfolios or manually decide the ratios of asset allocation. The automatic portfolio management is based on your age and risk appetite. There are three lifecycle portfolio choices in declining risk order: LC75 (Aggressive Lifecycle Fund), LC50 (Moderate Lifecycle Fund) and LC30 (Conservative Lifecycle Fund). Typically, after the age of 35, your equity and corporate debt allocation start to decline while allocation to government debt securities grows.

There are limits to equity exposure in each of the three lifecycle portfolio options, but one still has significant exposure for meaningful growth of one’s investments over the long run. It is important to note that once you turn 50, the equity allocation starts to decline, and by the age of 60, you cannot have more than 50 per cent of your portfolio in an equity fund.

THE ELSS ADVANTAGE

An ELSS is an equity-oriented mutual fund, which allocates a minimum of 80 per cent to equity and the rest to debt instruments. However, one has to pay a 10 per cent tax on long-term (over one year) capital gains above Rs 1 lakh. ELSS funds are unique mutual fund schemes that come with tax deduction benefits. There are several advantages of considering ELSS as a tax-saving instrument, the topmost being the shortest lock-in period of three years as compared to other Section 80C options, which have a lock-in of five years or more, the longest being 15 years for PPF. With its high equity allocation, the returns from ELSS can be high over the long term and help one build wealth.

Like in any mutual fund, one can invest in ELSS too through SIPs (systematic investment plan), making tax-saving investment convenient and easy. However, when investing through SIPs in ELSS, one should be careful to note that each SIP investment has to meet the 3-year lock-in. Even though ELSS provides SIP as an investment option, it should be avoided and a better way could be to divide the annual tax savings in ELSS into 2-3 tranches.

Among tax-saving instruments, ELSS has the shortest lock-in period of three years and high equity exposure for wealth creation

There is also a smart way to use tax savings in ELSS that could make tax planning convenient (see Smart Moves with ELSS) for life. At the highest 30 per cent tax bracket, one can save up to Rs 46,800 a year in taxes (including surcharge and cess) by investing up to Rs 1.5 lakh in ELSS.

Other than NPS and ELSS, the other investment-based tax-saving options include endowment life insurance plans, ULIP (unit-linked insurance plan) and certain retirement savings plans offered by insurance companies. While these options have equity exposure, they are not predominantly equity-oriented investments as all of them mix insurance in some form. Effectively, the entire premium that you pay does not go into investments. Moreover, these options also have fairly long lock-in, which one should get into based on their other financial needs.

The combination of ELSS and NPS can work very well for individuals. The NPS could be used for a focused long-term retirement savings and the ELSS for wealth creation. Both these instruments have significant equity exposure to provide wealth creation possibility. And one could use them in addition to existing retirement savings instruments that one may be part of, such as EPFO. Likewise, investing in ELSS could also be aligned to medium- to long-term financial goals such as a vacation 4-5 years from now or working on a down payment for a car. The idea of ​​investing to save tax is multi-pronged: you do reduce your income tax outgo, you are able to align your financial goals with tax savings and, lastly, you deploy your finances efficiently.

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