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Tax saving products for different types of investors

Learn about different taxation savings products for investors. Choose one based on your risk profile, investment horizon and tax liability.
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Importance of Tax Deductions and Exemptions

Deduction from taxable income at the investment time helps you start with a positive benefit right from day one. Exemption from taxation at the time of redemption or maturity benefits you by allowing you to keep all the returns that you made. In this article, we will understand taxation saving products for different types of investors.

Mutual funds & Tax Savings

An individual, depending on his/her risk profile, can invest in various mutual funds like equity, debt, or balanced funds. But, first, let us look at the taxation aspects of mutual funds.

At the time of investment

All mutual funds, except for equity-linked savings schemes (ELSS), are not eligible for any tax deduction at the time of investment. However, in a financial year, ELSS funds are eligible for a deduction of up to Rs. 1,50,000, from taxable income, under Section 80C of the Income Tax Act. ELSS funds are suited for investors with high-risk appetites and have a lock-in of 3 years.

At the time of redemption

The taxation for equity mutual funds and debt mutual funds at the time of redemption is different.

Taxation of equity mutual funds:

When the units of equity mutual funds are redeemed within 12 months, the gains are classified as short-term capital gains (STCG). The STCG tax is levied at 15%.

When the units of equity mutual funds are redeemed after 12 months, the gains are classified as long-term capital gains (LTCG). Every financial year, the first Rs. 1 lakh LTCG is exempt. After that, the incremental LTCG is taxed at 10% without indexation.

Taxation of other mutual funds:

When the units of other mutual funds (non-equity funds) are redeemed within 36 months, the gains are classified as short-term capital gains (STCG). The STCG is added to the investor’s overall income and taxed as per his/her income tax slab.

When the units of other mutual funds are redeemed after 36 months, the gains are classified as long-term capital gains (LTCG). The LTCG is taxed at 20% with indexation benefit and 10% without indexation.

Traditional life insurance plans & Tax Saving

Traditional life insurance plans include term plans, endowment plans, money-back plans, whole life plans, etc. While these are some of the traditional insurance plans available in the market, individuals should buy a term life insurance plan for protection. For returns, he/she should invest in other financial products and not in insurance products.

At the time of buying a traditional life insurance policy

When buying a traditional life insurance policy, the premium paid is eligible for a deduction of up to Rs 1,50,000, from taxable income, under Section 80C of the Income Tax Act. However, the annual premium paid in the financial year should be less than 10% of the sum assured.

For example, if the sum assured is Rs 10 lakhs, then the annual premium of up to Rs 1 lakh will qualify for deduction from taxable income. The incremental premium over 10% of the sum assured will not qualify for a deduction. However, in a pure term insurance plan, the premium is very unlikely to exceed 10% of the sum assured.

The policy should be in force, and premiums should have been paid for at least 2 years to avail of the deduction under Section 80C. If the policy is terminated or surrendered and not revived within 2 years, no deduction can be availed. Also, the deductions availed in previous years shall be deemed to be the income of the assessee of such previous years and shall be liable to tax.

At the time of maturity or life insured’s death

A traditional life insurance plan pays the life insured on maturity or the nominee on the death of the life insured during the plan tenure, subject to policy terms and conditions. The death benefit is exempt from taxation under Section 10(10D) of the Income Tax Act. However, the maturity benefit will be exempt from taxation under Section 10(10D), provided the annual premium is less than 10% of the sum assured.

Important note: The tax deduction at the time of investment and the tax exemption at the redemption/maturity/life insured’s death for a unit-linked insurance plan (ULIP) is different from what we have discussed above for traditional life insurance plans. However, ULIPs are out of the scope of this article.

Public Provident Fund & Tax Saving

The Public Provident Fund (PPF) is a fixed income product provided by the Government of India. It is one of the safest financial products to invest in due to sovereign guarantees. It is suited for investors with a low-risk profile and gives low to moderate returns. The PPF has a 15-year tenure. On maturity, it can be extended by a tenure of 5 years at a time. The account holder can take loans or make partial withdrawals, subject to specific terms and conditions.

Due to its long tenure of 15 years, a PPF account is suitable for accumulating funds for long-term financial goals. An investor can invest the debt proportion of his/her asset allocation in PPF. The Government announces the interest rate payable on PPF every quarter. The interest is credited to all PPF account holders at the end of the financial year. So, there is annual compounding in PPF. Let us understand the tax aspects of PPF.

At the time of investment

The amount deposited in a PPF account is eligible for a deduction of up to Rs. 1,50,000/financial year, from taxable income, under Section 80C of the Income Tax Act.

At the time of maturity

The maturity amount received from a PPF account is exempt from taxation under Section 10(11) of the Income Tax Act.

5-year tax-saving fixed deposit

In the earlier section, we discussed PPF. However, if the 15-year tenure seems too long, then you can consider opening a 5-year tax-saving fixed deposit. You can open one in a bank or a post office. As the name suggests, these fixed deposits have a 5-year lock-in. Therefore, you cannot make partial withdrawals or premature closure or take a loan against this fixed deposit.

It is suited for investors with a low-risk profile and gives low returns. However, when the inflation rate is running higher than the interest rate applicable on the fixed deposit, the product will yield actual negative returns.

At the time of investment

The amount deposited in a 5-year tax-saving fixed deposit is eligible for a deduction of up to Rs. 1,50,000/financial year, from taxable income, under Section 80C of the Income Tax Act.

At the time of maturity

The interest received from a 5-year tax-saving fixed deposit is taxable. The bank will levy Tax Deducted at Source (TDS) on the annual interest that is accrued. The Government specifies the TDS rate from time to time. If you wish to avail of the waiver of TDS, then you are required to submit Form 15G (for individuals below 60 years) or Form 15H (for senior citizens). However, you will still have to add the interest in your overall income and pay income tax on it as per your tax slab.

National Pension Scheme (NPS) & Tax Saving

The National Pension Scheme (NPS) is a social security financial product regulated by the Pension Fund Regulatory and Development Authority (PFRDA). The NPS can be used for accumulating a retirement corpus. On retirement, the investor can use the entire accumulated corpus or withdraw some amount and use the remaining corpus to purchase an annuity. The annuity can provide a regular income at specified intervals.

To accumulate the retirement corpus, the investor can make regular contributions to the NPS during his/her working years. The investor can choose to invest the regular contributions in a fund of his/her choice, depending on the risk profile. First, let us understand the tax aspects of NPS.

At the time of investment

Section 80CCD(1): Under Section 80CCD(1), a contribution made to the NPS is eligible for deduction from taxable income. For salaried employees, the maximum deduction allowed is 10% of salary or Rs. 1,50,000, whichever is lower. For self-employed individuals, the maximum deduction allowed is 20% of income or Rs. 1,50,000, whichever is lower.

The above deduction under Section 80CCD(1), clubbed together with deductions allowed under Section 80C and Section 80CCC, is a part of the overall deduction of Rs. 1,50,000 allowed under Section 80CCE.

Section 80CCD(1B): An individual can avail of an additional deduction of up to Rs. 50,000, in a financial year, under Section 80CCD(1B) for a contribution towards NPS. This deduction is over and above the Rs. 1,50,000 deduction allowed under Section 80CCE. So, an individual can avail of a total deduction of up to Rs. 2,00,000, in a financial year, for a contribution towards NPS.

Section 80CCD(2): Under Section 80CCD(2), an employee can avail deduction from taxable income for a contribution made by an employer to the employee’s NPS account. For the employer’s contribution, the maximum deduction that an employee can avail is up to 14% of salary in Central Government Employees and 10% of salary in the case of other employees.

So, the total deduction from taxable income that can be availed by an employee for a contribution towards NPS is the total of:

  • Rs. 1,50,000 under Section 80CCD(1) +
  • Rs. 50,000 under Section 80CCD(1B) +
  • Employer contribution (14% of salary for Central Government employees and 10% of salary for other employees) under Section 80CCD(2)

At the time of maturity

The NPS account matures on the investor reaching the retirement age of 60 years. On maturity, the investor has to buy an annuity with the accumulated NPS corpus. However, they have the option to withdraw up to 60% of the corpus, tax-free. This is known as commutation. Use the remaining corpus to buy an annuity. The periodic amount received under annuity is taxable. It is added to the individual’s overall income and taxed as per their income tax slab.

Asset allocation and Tax Saving

While investing for financial goals, an investor should invest as per his/her risk profile and asset allocation. Once the asset allocation is decided, the investor should identify products based on various parameters such as return potential, tenure, lock-in, liquidity, tax benefits at the time of investment and redemption/maturity, etc. While tax benefits are significant, they should not be the only consideration for deciding the financial product to invest in.

To find out about your risk profile and the correct asset allocation for your financial goals, you can partner with the Glide Invest App. You can plan and systematically invest towards your financial goals with Glide Invest. You will get guidance for:

  1. A personalised risk profile assessment
  2. Identifying your financial goals
  3. Appropriate asset allocation
  4. Making a financial plan for each goal
  5. Automating the financial plan
  6. Review and analysis of your financial plan 
  7. Hand holding you till your financial goals are achieved.

To start investing towards your financial goals, download the Glide Invest App now from Google Play Store or Apple App Store and get started.

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