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Showing posts with label Investments. Show all posts
Showing posts with label Investments. Show all posts

January 19, 2009

Reducing Your Taxes Through Investments

The Income Tax Act of India says that under section 80C, an individual can reduce his taxable income by Rs.1 lakh by investing in certain investment instruments. Following instruments come under section 80C:

  • Provident fund
  • National Savings Certificate (NSC)
  • Tax Saving Mutual Funds
  • Pension Plans
  • Fixed Deposits
  • Life Insurance policies

The maximum combined investments through all these instruments is one lakh in a year. But, in a hurry to invest people fail to realize that though deductions can be claimed by investing in such instruments, yet they end up paying tax on the income earned through interest or would be liable for capital gains tax on redemption of these schemes. Lets, have a look at these instruments.

1. Equity Linked Savings Schemes (ELSS): These are very high risk instruments. But, as risks are high so is the expected gains. This is also known as tax saving mutual funds. It has a lock in period of three years. Returns are not guaranteed as the amount invested is invested by a mutual fund in diversified stocks in the stock market. So, the return is purely dependent on the type of funds, track records and the performance of the stock market. One can save some money by buying directly from the mutual fund as there is no entry load if applied directly, or else you may end up paying an entry load of around two percent. It is one of the most important instrument as in the long run the stock market will see a rise.

2. Public Provident Fund: The risk involved is low. One can invest from a minimum of Rs.500 to a maximum of Rs.70,000 in a year. Interest rate is 8 per cent per annum compounded while the lock in period is 15 years. It should be noted that the interest earned is tax free, so, the effective yield becomes much higher after adjusting for tax benefit. But, the problem with this scheme is that one has to remember to invest at least an amount of Rs.500 every year for continuous 15 years or the account will become defunct. The other negative thing about this scheme is that the interest rates are fixed by the government from time to time.

3. Life Insurance Policy: Life is full of uncertainties. So, one should have some backup plans. One can invest in an insurance either from a investment point of view or take an insurance to cover your families in case of any wanted incident. From an investment point of view on can choose such policies that offers a guaranteed return on maturity. In other case, one can go for term insurance where your families will get the sum assured in case of death of the person insured. Premiums in insurance can vary from monthly to quarterly or half yearly or even annually. Similarly, a policy can have maturities from five years onwards. Premiums paid and proceeds received from an insurance policy is generally exempt from tax.

4. Fixed Deposits: These are low risk instruments. One should always note that only those fixed deposits which have a maturity period of five years or more are exempt from tax. The interests vary from banks to banks. One can have fixed deposits either in a scheduled bank or any post office. But, income from such fixed deposits are taxable. So, if one takes tax into consideration then, the effective yield will be lower than the interest paid.

5. National Savings Certificate: These are also low risk instruments. It comes in denominations of Rs.100, Rs.500, Rs.1000, Rs.5,000 and Rs,10,000. The forms are available at any post offices. The maturity period is six years while the interest rate is 8 per cent compounded half yearly. Here, too interest is taxable.

6. Government Infrastructure Bonds: The problem with these tax saving bonds are that they are open and available only for a fixed period. The major institutions that offer these bonds are ICICI, IDBI and Rural Electrification Corporation. Term periods can range from five to seven years and interest may vary from 6 to 9 percent per annum.

7. Pension Plans: These are highly risky instruments. Various insurance companies such as LIC, Tata AIG Life, Aviva, ICICI Prudential and Bharti Axa Life offer such pension plans. On maturity, the investor receives one-third of the amount while the remaining 2/3rd goes into an annuity that provides regular income in the form of pension. Only premiums till Rs.10,000 per year are eligible for deductions from total income. Like Unit Linked Insurance Plans (ULIP’s), a substantial amount of the money invested into Pension Plans goes into paying ‘fund charges’ and commissions. Moreover, the annuity received by the insured investor is taxable. Terms can extend from 10 years upwards. Though some return may be guaranteed but, a large part depends on the debt market, share market and inflation. Hence, high risk.

8. Unit Linked Insurance Plan: These are also very risk instruments. This is by far the worst tax saving instrument to invest your money in. A huge amount of commission, charges and entry load is deducted from the amount you have invested. The remainder is invested in a set of funds that invest in the debt and share market in different proportions. In some cases, the commission may be around 50 per cent of the amount invested. Term period is usually five years and above, while returns are not guaranteed as depends mostly upon market performance and how your plan performances.

9. Senior Citizens Saving Scheme: These schemes are for people over the age of 60 years and retired personnel over 55 years. This scheme is available at all public sector banks in the country. Investments have to be made in multiples of Rs.1000 till a maximum of 15 lakhs for a period of five years. The deposit made gets an interest of 9 percent per year from the date of deposit which is computed quarterly. Interest is taxable and is deducted at source.