Tax Saving - Planning Options for Employees

EPF and PPF

Returns: 8.5% (EPF) and 8 per cent (PPF) per annum

Maximum deduction: Rs 1 lakh for EPF; Rs 70,000 for PPF

Income: Tax-free


It's compulsory and it's safe. However, in March, the Employee Provident Fund's (EPF) chief importance is that it automatically reduces the amount you must invest to exhaust the Rs 1 lakh limit. Jokes apart, the EPF has several advantages for taxpayers. To begin with, it offers a steady return of 8.5 per cent. Secondly, you cannot withdraw the money until you retire or change your job. This means you are exploiting the power of compounding to the fullest over your career span.

The best part is that the interest and the withdrawals are tax-free, a benefit available only in a couple of other products.


All these features make the EPF ideal for investing for a retirement corpus. However, if you really need the money, the authorities have the discretion of allowing you one withdrawal during your career even if you haven't changed your job or have not retired. For this, you must submit proof of expense for which the withdrawn amount will be used. Typically, a trans-Europe trip does not qualify as adequate reason for dipping into the EPF. If these features seem attractive, you can increase the contribution to the EPF from the mandatory 12 per cent to 25 per cent of your basic salary.


The returns from the Public Provident Fund (PPF) are slightly lower at 8 per cent per annum, but the interest and withdrawals are tax-free. The advantage over the EPF is greater flexibility of withdrawals. The maturity period of the PPF is 15 years. However, you can dip into the fund from the seventh year onwards. The maximum limit of withdrawal is 50 per cent of the account's balance as in the previous year or in the previous three years, whichever is lower. The cut-off date for calculating the balance is March 31, the last day of the financial year.

In case you want the money before the seventh year, you can take a loan from the account up to 25 per cent of the balance in your account in the third year. The loan must be repaid in a maximum of 36 EMIs. The interest on the loan works out to 12 per cent. As the interest on the money is not redirected to the PPF, it may be good idea to avoid taking a loan.


Five-year FDs and NSCs

Returns: 7-8%

Maximum deduction: Rs 1 lakh

Income: Fully taxable


The National Savings Certificates are currently on a par with the PPF in terms of pre-tax returns. But they lose out to the PPF and EPF because the returns are taxable, thus reducing the post-tax yield. Needless to say, they are equally safe and have the advantage of a shorter lock-in period of six years.


The tax treatment of NSC income makes all the difference for taxpayers who have an income that falls within the 30 per cent tax slab. However, if you are a retiree or have an annual income lower than Rs 3 lakh, the tax rate is marginal (only 10 per cent, plus 3 per cent cess). Five-year fixed deposits also have a short lock-in period and offer almost the same returns. The difference is that the interest rates of FDs are more variable and the deposits in private banks are not as safe.


Senior citizens' savings scheme

Returns: 9 per cent per annum

Maximum deduction: Rs 1 lakh

Income: Fully taxable


Whether or not you are looking forward to a retired life, there is one sure reason to celebrate. It is called the Senior Citizens' Savings Scheme, which offers a higher rate of returns 9 per cent than most bank deposits. Though the income is taxable, it is unlikely that you will pay tax because the exemption limit for senior citizens is Rs 2.4 lakh per year.


The twist is that though you are eligible for earning 9 per cent interest after the age of 60, the tax exemption limit comes into effect only after you complete 65 years. Never mind this minor problem. The impact of the extra tax paid in five years will be minimal compared with the long-term benefits of this scheme. So do not ignore this option if you are planning a carefree retired life.


Equity-linked saving schemes

Returns: Market-linked

Maximum deduction: Rs 1 lakh

Income: Tax-free


They have been in the recovery mode since 2009, giving returns of about 76.1 per cent last year. This bounceback from the lows of 2008 (the ELSS funds lost 55.5 per cent on an average) proves that long-term investors cannot overlook the ELSS for saving tax. The returns offered by these funds are unmatched by any other tax-saving instrument. Of course, they have the same risk profile as other equity funds. However, you can play your cards right by choosing funds that have been consistent performers and by staying invested for long periods.


To further hedge your risk, you can invest via SIPs that give you the benefit of averaging out costs. This automatically makes tax planning a year-long affair, as it ought to be. You also have the option to choose dividend payouts for periodic payments. This doesn't affect the taxability of income as both dividends and capital gains at the end of the three-year lock-in period are tax-exempt.


Unit-linked insurance plans

Returns: Market-linked

Maximum deduction: Rs 1 lakh

Income: Tax-free

Last year, Ulips got a major facelift. The insurance regulator capped the difference between the gross yield and the net yield earned by a Ulip. The ceiling is 3 per cent for Ulips with a tenure of less than 10 years and 2.25 per cent for policies with longer tenures. However, mortality charges have been kept out of this calculation. The rule became effective from 1 January 2010.


Now that the steep charges are gone, you have hardly any reason to ignore this instrument that combines equity exposure, life cover and tax savings. In fact, if the Swarup Committee's recommendations are accepted, all the upfront commissions of Ulips will be phased out by 2011. Therefore, investing in this product will become more profitable. Understanding the features of this financial instrument is important to optimise its benefits. For instance, in addition to saving tax, Ulips can also act as an effective allocation tool. This is because Ulips allow investors to change the equity-to-debt ratio without any penalty for a fixed number of switches every year. Even if you are not market savvy and are unable to take the decision on your own, there are Ulips that change the allocation according to your life stage.


However, if you are looking at short-term returns, stay way from Ulips. This is because they may not be able to recover the upfront charges unless you stay invested for at least 10-12 years. Do not be swayed by agents who claim that you only have to pay premiums for a minimum period of three or five years. In this way, your corpus is not likely to grow enough and will only be able to pay the charges for the life cover.


Life insurance policies

Returns: 5-6%

Maximum deduction: Rs 1 lakh

Income: Tax-free


There may not be many advantages to the expensive endowment or money-back policies that your friend had recommended a few years ago, but there is one silver lining. The premium of the policy is covered by Section 80C of the Income Tax Act and is exempt from tax. This is not to say that you must buy such a policy now. If you are inadequately insured, opt for pure term plans, which are significantly cheaper than traditional policies. In fact, the premiums paid for all insurance policies that cover you, your spouse and dependent children are exempt from tax. But remember that experts are against buying insurance for saving tax alone. The latter should be an added advantage.


Pension plans

Returns: Market-linked

Maximum deduction: Rs 1 lakh

Income: Pension income taxable


It's a must-have for all investors. If your employer does not provide one, buy a pension policy that ensures a steady income after retirement. What can be better than earning tax benefits on the investment as well?


There are three types of pension plans to choose from. The first is the unit-linked pension plan. It offers greater control over your retirement corpus by allowing you to choose the mix of equities and debt according to your risk appetite. A unit-linked pension plan is not as costly as a Ulip because it does not offer life insurance.


However, keep in mind that on maturity, only 33 per cent of the corpus can be withdrawn tax-free. If you do not get gratuity, up to 50 per cent of the pension corpus can be commuted. You must use the balance to buy an annuity from an insurance company that will give a monthly pension.


This pension is fully taxable.

The second type of pension plan is offered as a mutual fund. In most of these funds, the money cannot be withdrawn before the investor turns 58. Even if early withdrawals are allowed, you have to pay a penalty. For instance, the Templeton India Pension Plan charges a hefty 3 per cent exit load on amounts withdrawn before the vesting age of 58.


The third option is the New Pension Scheme (NPS) launched with much fanfare in 2009. However, it is yet to attract investors in hordes. To know more about why the scheme has been a non-starter, read our story 'All you Need to Know About Pension' on our Website, www.moneytoday.in. Sign up only if you are convinced that the NPS has the potential to take care of your pension needs. The contributions fall within the Section 80C ambit.


Home loan EMI

Maximum deduction: Rs 1 lakh


For the past few months, the hefty home loan EMI had been one of the most important reasons employees feared the job axe. Now, the same EMI is cause to rejoice. The cumulative principal of your EMIs is eligible for a Section 80C deduction. This is usually a large amount and, along with the Provident Fund, should take care of most of your Rs 1 lakh limit. If you also factor in the deduction available under Section 24 on the interest paid, the effective loan rate comes down significantly.


Another way to increase the benefit is to take a joint loan with a sibling, spouse or parent. This way, both coowners of the property can claim individual tax benefits on the home loan. A word of caution: do not let tax saving inspire you to extend your loan tenure. It is equivalent to spending more to get a discount. The shorter the tenure of a mortgage, the better it is.


Tuition fees

Maximum deduction: Rs 1 lakh


The ever-increasing school fees of your children could burn a hole in your wallet. There is some respite because the tuition fee of up to two children is taxdeductible. Note that only the tuition fee is included. Other myriad charges in various forms, such as the building development fee, bus fee, etc, are not eligible for deduction. Another rider is that the fee must be paid to a recognised educational institution in India. This means that playschools, foreign colleges and private coaching classes do not qualify. Also, the fee must be paid for the taxpayer's children, not siblings, nephews, nieces or grandchildren.


The benefit cannot be availed of by both the parents. If there's one child, only one of the parents can claim tax benefits on the school tuition fee. Otherwise, each parent can claim tax benefit for different children. Even so, the tax benefit is helpful, especially for those who can't save enough to cut taxes.

via Indiainfoline/Money Today