Household savings are primarily held in fixed deposits, states the Reserve Bank of India’s (RBI) annual report 2022. Fixed deposits account for 6% of gross national disposable income (GNPI), while equities account for 0.5%. However, there is a larger issue impeding wealth growth: tax inefficiency. People are so focused on tax deductions that they overlook efficient tax planning and frequently ignore the growing chunk of their hard-earned income paid as taxes.
For many businesses and individuals, the end of a fiscal year is a critical time. And the time has come to raise awareness and participation in all aspects of tax planning. People frequently express their dissatisfaction with the tax burden and how it affects their ability to create wealth. With talk of the old tax regime being phased out and a limited set of tax deductions available, individuals should focus on tax efficiency, which is essentially maximizing after-tax returns. Taxes can have a significant impact on long-term investment returns, which, when combined with the aftereffects of inflation, can lead to the failure of financial goals.
The Indian government offers a variety of tax-saving instruments in which you can invest. Here are some of the most popular tax-saving investments that are worth the effort and investment.
Employee Provident Fund (EPF): This retirement benefit program is available to salaried workers. The employer in this case deducts 12% of the basic salary and Dearness Allowance (DA). The money is then deposited in provident fund programs approved or recognized by the government.
Public Provident Fund (PPF): These are government-backed investments with a 15-year lock-in period. After seven years, you can withdraw some of your money back in a partial withdrawal and earn an interest rate of roughly 7%. Every quarter, the government declares the PPF interest rate, which is fixed and earned on this tax-saving instrument. As it offers guaranteed interest that has been declared by the central government, PPF functions as a fixed return instrument.
Equity Linked Savings Schemes (ELSS): These mutual fund tax-saving schemes offer high market-linked returns in addition to tax savings. A three-year lock-in period is a bare minimum for these. In comparison to other comparable financial instruments in the market, these tax-saving ELSS funds offer the highest return by investing approximately 80% of their total portfolio in equity securities. Comparatively speaking to other securities offered under the same umbrella, tax-saving ELSS funds are a relatively liquid investment.
Sukanya Samriddhi Account: The annual investment cap for this government-sponsored program is Rs 1.5 lakh. If you’re the parent of a girl child, you can open an account in her name and receive interest on investments up to Rs. 1.5 Lakhs. Currently, this government scheme offers an interest rate of approximately 7.6%, higher than that across other government-mandated instruments, like the Public Provident Fund, as part of the “Beti Bachao Beti Padhao” policy.
Tax Saving Fixed Deposit: Similar to traditional fixed deposits these deposits have a minimal lock-in period of upto 5 years. This is a good investment instrument for those investors who are risk averse. However, keep in mind that any early withdrawals will negate any tax benefits associated with such investments. And, taxes must be paid on interest received under this plan.
National Saving Certificate (NSC): These have a minimum lock-in period of 5 years. An investor may select from either of the two fixed maturities on this investment, which are five or ten years. The interest accrual of up to 7% is compounded on an annual basis. NSC offers safe investments for investors weary and concerned about stock market fluctuations.
The National Pension Scheme (NPS): This is a government-run social security program that offers retirement benefits to workers in the public, private, and unorganized sectors. In the case of those who are paid a salary, it accepts contributions from both employers and employees. An employee is permitted to invest up to 10% of his or her salary tax-free under Section 80CCD (1). Section 80CCD (1B) of the Income Tax Act allows self-employed people to claim additional NPS tax benefits of Rs. 50,000. Money placed in an NPS account may be partially reinvested in equity plans, depending on the investor’s choice.
Make a plan ahead of time to give yourself more time to research and select effective tax-saving tools. This simple change can provide you with more liquidity and a higher return at a lower risk, allowing you to meet your financial goals more effectively. For instance, the following are some examples of common inefficiencies in investment tax planning:
Keeping Loans Alive: Keeping loans open to lower tax obligations is customary, but this strategy needs to be reevaluated. Why? One, there is a 2 lakh annual cap. And two, the difference between the true value of saved taxes is negligible when compared to the total interest expense incurred given the price of housing in India. Not to mention the recurring financial strain and the fluctuating mortgage rates, which only increase the interest expense.
Insurance and Investing Combined: Separate your insurance from your tax-saving investments. Traditional life insurance products, which are a combination of insurance and debt investment, frequently provide poor returns. The returns are typically lower than those offered by PPF or other savings plans. Additionally, they have longer tenures, lower liquidity, and penalties for premature closure. Purchasing such policies at the last minute means you will be saddled with inefficient products.
There are numerous other mistakes that people make in their rush to invest before the tax deadline and save money on taxes. One such blunder is borrowing to invest where they end up paying more in interest owed for the amount borrowed. Another example is rushing into assets that lack diversification. The risk of a poorly diversified portfolio can be far more damaging than the amount of taxes owed.
Precisely like goal-setting in financial planning, tax planning is an essential part of investing too. Asset allocation and diversification are basic principles that apply to managing tax-saving investments as well. As we begin a new year, let us focus on our finances and ensure that our hard-earned money is carefully invested and working towards our financial independence goals.
