1. What is a tax deduction?
A tax deduction is simply an item that helps you reduce your taxable income by the amount of the deduction. So by utilizing that particular deduction, you can reduce the amount of income tax by reducing the amount of your taxable income.
For example: If you have a taxable income of Rs. 2,50,000 for the financial year, and you invest Rs. 70,000 in PPF and Rs. 30,000 in Equity Linked Savings Schemes, then your taxable income is: Gross Taxable Income: Rs. 2,50,000
Deductions:
PPF: Rs. 70,000
ELSS: Rs. 30,000
Total Deductions: Rs. 1,00,000
Net Taxable Income: Rs. 1,50,000
2. How can I save tax using different tax deductions?
There are different tax deductions available to an individual under different Sections of the IT Act. Section 80C for example has a deduction limit of Rs. 1 lakh per annum.
You can save tax by making use of the various deductions available to you under different sections of the IT Act i.e. investing in these instruments.
3. What are the investment options available under Section 80C?
The specified investment schemes under section 80C are:
a. Life Insurance Premiums
b. Contributions to Employees Provident Fund (EPF)
c. Public Provident Fund (PPF)
d. National Savings Certificates (NSC)
e. Unit Linked Insurance Plan (ULIP)
f. Repayment of Housing Loan (Principal)
g. Equity Linked Savings Scheme (ELSS) of Mutual Funds
h. Fixed Deposit (FD) with Banks having a lock-in period of five years
i. Pension Funds
4. Does Section 80C include Section 80CCC and 80CCD?
Yes. The total deduction available under Section 80C is Rs. 1 lakh, inclusive of Section 80CCC and Section 80CCD. These two sub sections are to do with pension. Under Section 80CCC, you can invest up to Rs. 1 lakh in a Pension fund of LIC of India or any other insurance company. Under Section 80CCD you can invest in the National Pension Scheme of the Central Government up to 10% of your salary. Any contribution to this scheme of more than 10% of your salary will not be eligible for tax deduction.
5. What is the limit for Section 80CCF: Long Term Infrastructure Bonds?
An additional deduction of Rs. 20,000 has been introduced by way of investment into long term infrastructure bonds.
Here, any investment made into the specified long term infrastructure bonds between April 1st, 2010 and March 31st, 2011 will be eligible for a tax deduction up to Rs. 20,000.
This is in addition to the Rs. 1 lakh deduction available under Section 80C.
This is not applicable for Year 2012 - 2013
6. How does Life Insurance Premium payment contribute to Section 80C investment?
An amount up to Rs 1 lakh that you pay towards life insurance premium for yourself, your spouse or your children can be included in Section 80C deduction and reduced from your taxable income.
If you are paying premium for more than one insurance policy, all the premiums can be included, subject to the limit of Rs. 1 lakh.
a. Can I include life insurance premiums paid for my parents?
No. Life insurance premium paid for your parents or your in-laws is not eligible for deduction.
b. Does this apply to all life insurance products such as endowment, money back, term plans, ULIPs etc?
Yes. Any premium paid for any life insurance in any life insurance product is eligible for tax deduction under Section 80C.
Also note that any sum, including the bonus, received on maturity of a life insurance policy is tax free. Death benefits received are also exempt from tax.
Most importantly, remember to invest in a life insurance policy only if you need it, and not for the tax benefit. If you opt for it keeping in mind the tax benefit, you may end up being under-insured or possibly over-insured.
7. How do I save tax by contributing to my employee's provident fund?
The EPF is a scheme intended to help employees from both private and non-pensionable public sectors save a fraction of their salary every month in a savings scheme, to be used in an event that the employee is temporarily or no longer fit to work or upon retirement.
An employee can withdraw full amount at the credit in the fund on retirement from service after attaining the age of 55 year.
EPF is automatically deducted from salary. Both employee and employer contribute to it. Employee's contribution is counted towards Section 80C investments.
Employees also have the option to contribute additional amounts through voluntary contributions (VPF).
Summary of Employees Provident Fund
| Return (p.a.) | 8.5% | |||
| Risk | NIL | |||
| Lock In | Working Life | |||
| Income from Investment | Interest earned is Tax Free | |||
| Maturity Proceeds | Exempt under Section 10(11). | |||
| NRI/PIO eligible | Yes | |||
8. How to save tax by contributing to the Public Provident Fund (PPF)?
PPF is eligible for tax deduction up to Rs. 70,000. So any amount up to Rs. 70,000 invested towards your PPF account will be eligible for tax deduction. The minimum investment in PPF is Rs 500 per year and the maximum investment is Rs 70,000 per year.
The unique feature of PPF is that in case of insolvency it will not be attached to the assets of the insolvent. So this is an attractive tax saving tool for business people in fluctuating and highly leveraged businesses. Withdrawals from your PPF account are allowed during certain years for specific purposes.
Summary of PPF Details
| Return (p.a.) | 8.0% | |||
| Risk | NIL | |||
| Lock In | 15 years | |||
| Income from Investment | Interest earned is Tax Free | |||
| Maturity Proceeds | Exempt from tax. | |||
| NRI/PIO eligible | No | |||
9. How to save tax by investing in National Savings Certificate (NSC)?
NSC is a good medium term investment option. An advantage of the NSC is that it can be pledged as security against a loan to banks/ government institutions.
The minimum investment starts from Rs 100 and there is no maximum limit for the investment in a year.
| Return (p.a.) | 8.0% compounded half-yearly, i.e., the effective annual rate of interest is 8.16%. | |||
| Risk | NIL | |||
| Lock In | 6 years | |||
| Income from Investment | · Interest accrued every year is liable to tax (i.e., to be included in your taxable income). · However, interest is also deemed to be reinvested and thus eligible for section 80C deduction. | |||
| Maturity Proceeds | It includes interest which is already taxed | |||
| NRI/PIO eligible | No | |||
10. How to save tax by taking a Unit Linked Insurance Plan (ULIP)?
Unit-Linked Insurance Plan (ULIP) is life insurance solution that provides for the benefits of risk protection and flexibility in investment. Part of the premium you pay goes towards the sum assured (amount you get in a life insurance policy) and the balance will be invested in whichever investments you choose as per what is available under the scheme - equity, debt or a mixture of both.
Summary of ULIP Details
| Return (p.a.) | Market linked | |||
| Risk | Market and Fund manager risk | |||
| Lock In | 5 years | |||
| Income from Investment | N.A. | |||
| Maturity Proceeds | · Exempt under Section 10(10)D for any sum received from insurance policy as maturity proceeds. Death benefits are exempt from tax. · However for ULIPs the maturity benefit is tax free only if the premium paid per year is less the 20% of the life insurance cover. In other words the life cover has to be at least 5 times the premium. | |||
| NRI/PIO eligible | Yes | |||
11. How to use home loan to save tax?
The EMI (equated monthly installment) that you pay to repay your home loan consists of two components - one is the principal and the other is the interest. The principal component of the EMI qualifies for deduction under section 80C.
Even the interest component can save you significant income tax - but that would be under Section 24 of the Income Tax Act. Currently, anybody with a housing loan gets a deduction up to Rs 150,000, paid as interest for the loan, from his total income, for a self occupied property.
For more information on how a home loan can help you save tax – please see our Section on Income from House Property (Question 10).
12. How to save tax by investing in Equity Linked Savings Schemes (ELSS)?
Investment in ELSS is considered to be one of the best option to save tax because of many reasons like low expenses, short lock-in period, high liquidity and high growth in long-term. Year 2008 and 2009 had been extremely volatile. Still, many mutual funds have delivered positive return in past 3 years.
The limitations in ELSS are that premature withdrawal is not allowed. There is a 3 year lock in period. Also ELSS returns are not guaranteed as they are market linked investments.
Summary of ELSS Details
| Return (p.a.) | Market linked | |||
| Risk | Market and Fund manager risk | |||
| Lock In | 3 years | |||
| Income from Investment | Basically, dividend which is Tax Free | |||
| Maturity Proceeds | Long term capital gain on sale of equity oriented mutual fund is tax free. | |||
| NRI/PIO eligible | Yes | |||
13. How to save tax by investing in Bank FD?
A fixed deposit is meant for those investors who want to deposit a lump sum of money for a fixed period; say for a minimum period of 15 days to five years and above. Investor gets a lump sum (principal + interest) at the maturity of the deposit.
The 5-year tax-saving bank deposit gives tax benefit under Section 80C as the amount you invest in the 5 year FD is deducted from your taxable income.
However interest received on the FD is taxable.
Summary of 5 Yr Bank FD Details
| Return (p.a.) | Typical interest rate is 8.00 to 8.50% with an additional 0.25 to 0.5% for senior citizens. The interest rate varies between banks and with time. | |||
| Risk | NIL | |||
| Lock In | 5 years | |||
| Income from Investment | Interest received is taxable | |||
| Maturity Proceeds | Includes interest which is already taxed | |||
| NRI/PIO eligible | Yes | |||
14. How to save tax investing in New Pension Scheme?
This is a new, market-linked vehicle for those who do not have an EPF facility to target long-term retirement planning. It is open to any Indian citizen between the age of 18 and 55. Minimum investment is fixed at Rs. 6,000 p.a.
The NPS offers two accounts: tier I and tier II. Currently only tier I account is available. This is a non-withdrawable account and investments in this keep accumulating till you turn 60.
Summary of New Pension Scheme Details
| Return (p.a.) | Market Linked | |||
| Risk | Market and Fund Manager Risk | |||
| Lock In | Till age of 60 | |||
| Income from Investment | N.A. | |||
| Maturity Proceeds | · Tax will be levied if you withdraw the money on maturity · You can save paying tax by transferring the entire corpus to an annuity service provider and receiving a pension | |||
| NRI/PIO eligible | No | |||
15. How to save tax by investing in Senior Citizens Savings Scheme (SCSS)?
It allows a retired person having a lump sum to invest it at a reasonably good interest rate. If you are 60 years old (or took voluntary retirement at 55), you are eligible for the scheme.
Minimum Investment under the scheme is Rs. 1,000 and maximum Rs. 15 lakhs.
The amount invested into SCSS is eligible for tax deduction under Section 80C thus reducing your taxable income in the year of investment.
This is a popular investment with senior citizens as it offers liquidity as well as periodic income – interest is paid out quarterly.
Summary of SCSS Details
| Return (p.a.) | 9% | |||
| Risk | NIL | |||
| Lock In | 5 years (May be extended for another 3 years at the option of depositor) | |||
| Income from Investment | Fully taxable | |||
| Maturity Proceeds | Maturity proceeds includes interest which is already taxed every year | |||
| NRI/PIO eligible | No | |||
16. How to save tax by investing in Post Office Time Deposit (POTD)?
POTDs are similar to bank fixed deposits.
Although available for varying time duration like one year, two year, three year and five year, only 5-Yr post-office time deposit (POTD) qualifies for tax saving under section 80C.
The current rate of interest on the 5 year POTD is 7.50% p.a., compounded quarterly. The minimum investment amount is Rs. 200, there is no maximum investment amount. Interest on these deposits is calculated quarterly and paid out annually.
| Return (p.a.) | Effective 7.71% as interest is compounded quarterly | |||
| Risk | NIL | |||
| Lock In | 5 years | |||
| Income from Investment | Fully taxable | |||
| Maturity Proceeds | Maturity proceeds includes interest which is already taxed every year | |||
| NRI/PIO eligible | No | |||
17. How to save tax using Pension Plan?
Today pension plans are available with all life insurance companies. They typically come without any life cover (zero death benefit).
Pension funds are exempted under Section 80CCC, this section stipulates that an investment in pension funds is eligible for deduction from the income.
Section 80CCC investment limit is clubbed with the limit of Section 80C which means that the total deduction available for 80CCC and 80C is Rs 100,000. This also means that your investment in pension funds up to Rs 100,000 can be claimed as deduction under section 80CCC.
Of the maturity amount only one-third can be commuted in cash as tax free maturity. The rest of the amount (or the full amount as the case may be) has to be used to by a pension plan (annuity). Pension receipts from the same will be treated as income in the hands of the assessee and taxed accordingly. Recently, the Insurance Regulatory and Development Authority (IRDA) has come out with a clear rule that maturity amount should not be withdrawn as cash this is coming to effect from July 1, 2010. Currently, the maturity amount can be withdrawn as cash but the amount will be added to income and will be taxed accordingly.
Now that you know about the various investment instruments available, before you invest – ask yourself the following questions:
0. How much risk are you willing to take on the investment?
1. For how long will you not need to use these funds? i.e. what lock in period is suitable for you?
2. Do you want your returns to be tax free?
3. Do you want the maturity values of your investments to be non taxable?
4. Do you need liquidity?
| S. No. | Factor | Criteria | ||||
| 1. | Risk and Returns | · Fixed rate of return with more safety - NSC, PPF, Bank FD OR · Market return with more risk - ELSS or ULIP. | ||||
| 2. | Lock-in period | · Range: Up to 15 years lock-in; · ELSS has the least lock-in period of 3 years, whereas PPF has the highest of 15 years; · Others fall in between | ||||
| 3. | How return are taxed | The most crucial part is to look at how the returns are taxed. · Only PPF and ELSS offer tax free returns; whereas · Interest on NSC, Post Office term deposits and bank FDs is taxable | ||||
| 4 (a) | Tax Treatment on Maturity | · Usually products offer tax deduction on investment · Few offer tax exemption on returns at the time of maturity · The taxability on maturity reduces the effective return that an investment offers. | ||||
| 4 (b) | EEE or EET category | · Exempt-Exempt-Exempt (EEE) tax status - tax benefits at the investment stage, the accrual (accumulation) stage and maturity stage - PPF, ELSS and Life Insurance · Exempt-Exempt-Tax (EET) tax status - tax benefits at the investment stage and the accrual (accumulation) stage and are taxed at the maturity stage - Bank FDs. · In the new Direct Tax Code, lot of investment products will shift from EEE to EET wherein these products will be taxed at the maturity stage | ||||
| 5. | Maximum Investment Limit | · If a product has maximum investment limit in a year, a tax payer will not be able to claim entire tax benefits for any amount invested above the maximum limit; · PPF has maximum investment in a year of Rs. 70,000 · In case of ELSS and ULIPs there is no maximum investment limit. | ||||
| 6. | Liquidity | · Most tax saving investment products come with a lock-in period; · PPF allows partial withdrawal during the 15 years tenure of the investment. · Tax savings bank FD cannot be broken before maturity and also banks normally don't give loans against these FDs. · Traditional Life insurance policies and ULIPs allow partial withdrawals but only after completion of 3 years. Also, as an investor you can take loans against life insurance policies. · An investor can also take loan against NSC Certificates. | ||||
| 7. | Inflation protection | · Returns from financial products should beat inflation; · Low fixed returns products are to be avoided by investors during periods of high inflation as they yield negative returns. · In the long run equities have consistently given higher inflation adjusted returns than returns given fixed return securities. | ||||
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