A Quick Guide to Tax Saving

As New Year celebrations draw to a close, the clock starts ticking on another important milestone of the year – tax saving. Although this should be an ongoing exercise, most start thinking about this crucial aspect of financial planning late in the year. If you are among the late starters, here’s a last-minute guide to making the most of deductions and exemptions.

Start by taking a note of the tax saving expenses you already have like child’s tuition fee and home loan repayment. The next step is figuring out the best tax saving investment.

However, before starting, choose your tax regime. From FY2021, you have an option of paying tax under a concessional tax regime which disallows most deductions and exemptions. In both regimes, a rebate is available if your net taxable income is ₹5 lakh or less. “If you opt for deductions up to 20% of your income, the old regime is better. With higher income, it may no longer be possible for you to get to 20% deductions,” says Adhil Shetty, CEO, BankBazaar.com. After deciding, start with tax-saving expenses.

Expenses That Count

Tuition fee: School fee for up to two children qualifies for deduction of ₹1.50 lakh under Section 80C of the Income Tax (I-T) Act. The deduction is not available for donations, development fee and coaching fee.

Life insurance premium: Section 80C of the I-T Act allows up to ₹1.50 lakh deduction for premium paid for life insurance of self or spouse. The maturity amount is tax exempt, except in case of Ulips, where it is exempt only if annual premium of the policy is less than ₹2.5 lakh.

Home loan interest/principal repayment: You can claim ₹1.50 lakh deduction under Section 80C for home loan principal. Stamp duty and registration charges are also eligible for this deduction. You can also claim ₹2 lakh deduction on home loan interest. In case of let-out property, the tax benefit is limited to interest paid. If you are claiming these deductions, you can’t sell the property before five years of the possession, otherwise the deduction claimed will be added to your income during the year of the sale. First-time buyers get an extra ₹50,000 benefit on interest payment.

Health insurance premium: Section 80D of the I-T Act provides ₹25,000 deduction for premium paid for insuring health of self, spouse and dependent children. The Section further allows up to ₹25,000 deduction for premium paid for insuring parents’ health. Up to ₹50,000 deduction can be claimed for health insurance premium for senior citizen parents.

Health expenses: You can claim up to ₹75,000 deduction under Section 80DD on health expenses of a dependent with at least 80% disabilities. In case of severe disabilities, the amount is ₹1.25 lakh. The I-T Act also allows tax deduction for treatment of specific diseases of self or dependent family members for up to ₹40,000. In case of senior citizens, maximum deduction is ₹1 lakh.

Interest on education loan: Section 80E of the I-T Act allows deduction of interest paid on education loan for self, spouse or children. It is available for eight years from the year you start repaying the loan or until the interest is fully repaid, whichever is earlier. There is no deduction for the principal payment.

Any charity money paid to approved institutions can also be claimed as deduction under Section 80G. Section 80GGB and 80GGC allow 100% deduction on contributions to a political party in any mode other than cash.

Employees who do not get HRA and are paying rent can avail up to ₹60,000 deduction under Section 80GG of the I-T Act.

Tax Saving Investments

After expenses, look for tax saving investments, especially under the most popular Section 80C.

Which is the best option? Well, that depends on your goals, risk profile and time in hand. When you are young, in early 20s, your primary goal should be savings. If you are above the zero tax mark at this stage, you may invest in equity linked savings schemes (ELSS) or tax-saving mutual funds, preferably via SIP, in a top-rated fund, says Adhil Shetty. “It has the lowest lock-in (three years) of any 80C investment. If you’re averse to stock market risks, invest in Employee Provident Fund or Public Provident Fund; however, be aware of the long lock-in periods,” he says.

Experts highly recommend a combination of ELSS and provident fund(s). “I do not recommend other options due to poor returns, long lock-ins and various rules that make them unrewarding,” says Shetty. But one of the fixed income investments he recommends is Sukanya Samriddhi Yojana (SSY) for girl child. Though it has a 21-year lock-in, the interest rate is pretty decent for an assured return scheme.

Tax Saving Mutual Funds (ELSS): Most financial planners swear by tax-saving mutual funds. ELSS is an open-ended equity-linked savings scheme with a three-year lock-in and tax benefit. These funds have delivered an annualised return of 22%, the highest among all tax saving investments, in past three years. However, one should not expect such high returns generally, as last two years have been extraordinary for equity markets. The benchmark BSE Sensex has risen 45% since the start of 2020, a performance that is unlikely to be repeated.

“With the lowest lock-in period, ELSS funds mimic equity market returns and remain the best tax saving instrument. One can expect above-average risk-adjusted returns of 12-15% over three to five years,” says Raghvendra Nath, MD, Ladderup Wealth Management. ELSS funds have returned 16.65% on an anualised basis in last ten years. However, these are not for conservative investors, as stock markets can fall anytime. These are recommended for investors with high risk appetite and time horizon of at least five-seven years.

National Pension System (NPS): Thus is a government-backed low-cost option to save for retirement. There are two types of accounts. The Tier-I NPS account offers three kinds of deductions. You can claim tax benefit under Section 80 CCD (1) within overall cap of ₹1.5 lakh under Section 80 CCE. Additionally, there is a deduction for up to ₹50,000 under subsection 80CCD (1B). Thirdly, a corporate subscriber may avail a deduction of up to 10%of salary (basic + DA) on employer’s contribution under Section 80CCD (2) of the I-T Act.

As per rules, 60% of the NPS corpus can be withdrawn at the age of 60. This amount is tax free. The remaining 40% has to be spent on buying annuity. Premature withdrawal is allowed in specific cases. If the corpus is below ₹5 lakh, you can withdraw the entire amount, without purchasing annuity.

NPS also has a voluntary account, called Tier-II, with flexible withdrawal and exit rules. Just like equity mutual funds, NPS schemes have delivered double-digit returns in last two years. Should it be a reason for you to invest? Well, return is just one aspect, says Nath of Ladderup. NPS is a pension product. Once invested, the amount cannot be withdrawn till the retirement age of 60. The decision to invest will depend upon the investor’s overall financial plan.

NPS is suitable for investors with low to medium risk profile. For those with high risk tolerance, the 75% equity allocation cap is a drawback.

Some experts say tax payers are better off avoiding NPS. “Investing simply for wealth creation via mutual funds, equities or any other option that delivers double-digit returns over the long term is a better option,” says Adhil Shetty. Some say that mandatory annuity purchase requirement significantly lowers post-retirement returns. However, NPS may be utilised by those looking to build a secure retirement corpus while saving tax.

Public Provident Fund (PPF): This government-backed instrument, despite its 15-year lock-in, is a popular option to save tax under Section 80C due to its EEE tax status (tax exemption at all three stages, deposit, interest accrual and withdrawal). The 15-year tenure can be extended by another five years. The current interest rate is 7.10%, the lowest since 1977. One withdrawal is allowed after five years, excluding the year of account opening.

Sukanya Samriddhi Yojana (SSY): This government of India scheme is eligible under Section 80C. Its tax status is also EEE. The account can be opened by parents or guardians of a girl child till she is 10. The account matures after 21 years or at the time of marriage after the girl turns 18. It can be opened for two daughters. The combined investment can be up to ₹1.5 lakh in a year. At present, SSY is offering 7.60 per cent per annum, the highest among debt-oriented small savings schemes.

The account can be closed after five years in case of death of the account holder or the guardian. The investor is allowed to withdraw up to 50% of the deposit once the girl touches 18 or after she passes Class X.

Tax Saving Fixed Deposit: Bank tax-saving deposits have a five-year lock-in. At present, SBI tax saving deposit is offering 5.40%. Senior citizens get 6.25%. Interest from these deposits is added to income and taxed. But interest income up to ₹10,000 from savings bank, co-operative bank and post office deposits (taken together) is not taxed. Any amount above this is taxed as income from other sources.

Senior citizens can claim deduction of up to ₹50,000 on interest from fixed deposits or savings accounts with banks, co-operative banks and post offices under Section 80TTB.

National Savings Certificate (NSC): This is a safe investment with a tenure of five years. NSC offers guaranteed interest. It is government-backed. The current rate is 6.8%, compounded annually, but payable at maturity. The interest earned every year is not paid annually but is reinvested. The interest amount which gets reinvested qualifies for fresh deduction under Section 80C. Interest is taxable at maturity.

Senior Citizen Savings Scheme (SCSS): This government-backed scheme is for those above 60. An individual may invest up to ₹15 lakh in lumpsum. The tenure is five years. The account holder has an option of extending it for three more years within one year of maturity. At present, it is offering 7.4% per annum, payable quarterly. This makes it a great way to get regular income.

But one of the major drawbacks is that interest earned is taxable if it exceeds Rs 50,000 in a financial year.