Saving tax for salaried individuals in India – Top Tax Saving Investments
I am writing about how to avoid paying tax or paying as little as possible tax in three blog posts – calculating taxable income, deductions before tax and tax slabs. This section is about a few common ways to save tax by reducing your net taxable income through investments, expenses and loans.
Tax Deductions Through Investments
According to Section 80C of the Income Tax Act, you can reduce your taxable income by Rs.1 lakh by investing in certain investments. These investment can be from any one source or a combination of sources such as Public provident fund, national savings certificate, tax saving mutual funds, pension plans, fixed deposits and life insurance policies. Since, the returns on investment, risk factors, term of deposit and entry load or commissions vary for each type of investment, here is some information about each type to help you select the best according to your needs. They are arranged as the best investments for young salaried tax payers in India according to the ones which I prefer the most –
1. Equity Linked Savings Scheme (ELSS) – High Risk. Also known as tax saving mutual funds, an ELSS has the lowest lock in period of 3 years. As the money invested in an ELSS is invested by mutual funds in diversified stocks in the stock market, there is no guaranteed return. Dividends and profits from redemption of units after the term period is tax free. If you buy directly from the mutual fund instead of a broker/distributor, then you pay zero entry load, else entry load is around two percent. Remember, in the long run, the stock markets always see a rise.
2. Bank or Post Office Fixed Deposits – Low Risk. Only investments made in scheduled banks for a period of five years or more can be counted as a Bank Fixed Deposit. The interest on such fixed deposits is around 8-9 percent. Income from interest is taxable. Forms are available at bank and post office counters.
3. National Savings Certificate – Low Risk. It comes in denominations of Rs.100, 500, 1000, 5000 and 10,000. The forms are available at any post office. The maturity period is six years while the interest rate is 8 percent compounded half yearly. If you pay in cash, you will be given the National Savings Certificate then and there. If you pay by cheque, you will have to wait a week before you can collect the NSC certificate from the post office. Interest is taxable.
4. Life Insurance Policy – If you are looking for life insurance cover along with investment, then you should choose one such policy that offers a guaranteed return on maturity. If you have a huge loan to pay off and a family it is better to go for a cheap traditional term insurance where you don't get the premium back but have a huge insurance cover in case of any untoward incident. Premiums can vary and may be paid monthly, quarterly, annually or in a lump sum depending on the policy you choose. Term of the policy can vary from five years till twenty years and more. Money received from an insurance company as proceeds of an insurance policy (by way of an insurance claim, or by maturity) is generally exempt from tax.
5. Government Infrastructure Bonds – Low Risk. The main problem about these tax saving bonds are that they are open and available only for a fixed period. As many bonds open around February, they miss the January 31 deadline of submitting investment proof prevalent in most offices. 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. Forms for Tax Saving bonds are available at local distributors that sit on the pavement outside major banks. Companies like ICICI have not come out with tax saving infrastructure bonds for a long period now.
6. Public Provident Fund – Low Risk. The investment limit is Rs.500 to Rs.70,000 per year - in multiples of Rs.5. The main problem about this scheme, is that you have to remember to invest an amount of at least Rs.500 annually for 15 years or your account will become defunct. Interest rate is 8 percent per annum compounded while the lock in time period is15 years. Another negative point is that as interest rates are on the downside and they are routinely changed by the government they may see a further fall. As interest for the financial year is calculated on the lowest balance after March 5th, make sure you invest before that date. PPF Accounts may also be made in name of your spouse or kids for tax benefit. You can open a Public Provident Fund Account at main post offices, branches of the State Bank of India and some nationalised banks.
7. Pension Plans – High Risk. Life 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. Plus, the annuity received by the insured investor is taxable. Terms can extend from 10 years upwards. Though some return may be guaranteed – a large part depends on the debt market, share market and inflation.
8. Unit Linked Insurance Plan – Very High Risk. 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, this commission may be around 50 per cent of the amount invested. Most telecallers sell this type of policy, and if you ask them how much will actually be invested, they pretend they don’t understand the question. An ICICI Prudential executive however told me that one third would go in extra charges – that is a whopping 33.3 percent. Term period is usually five years and above while returns are not guaranteed.
7. Senior Citizens Saving Scheme – Only people over the age of 60 years and retired personnel over 55 years are allowed to invest in this scheme. 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.
You can also check out Prem Arora's post for more information on tax saving schemes.
Tax Deductions For Expenses
Other than the investments above that qualify for a deduction from total income, there are also certain expenses that are tax deductible such as home loans, education loans, tuition fees, medical insurance premium and treatment for specified terminal diseases. Here is some information about the most common expenses which are tax deductible in India.
1. Home Loan – If you are repaying such a home loan, the principal amount of the loan taken can be counted as a deduction under Section 80C of the Income Tax Act.
2. Tuition Fees of Children – The tuition fees of upto two children at school, college and university level may also be taken as a deduction from total income thus reducing the amount on which tax will be calculated.
3. Interest on Home Loan - According to Section 24, a tax exemption of up to Rs. 1,50,000 is allowed on the interest paid for a home loan in the current financial year.
4. Medical Insurance Premium - Section 80 D - An amount of up to Rs.15,000 for individuals and Rs.20,000 for senior citizens as premium towards a medical insurance or mediclaim policy is tax deductible. This also includes medical insurance for dependents such as spouse, children or parents on the condition that you paid the premium.
5. Education Loan – Section 80E - The yearly limit for deduction is Rs. 40,000 (for both the principal and the interest). Only loans taken for higher education - fulltime studies in any graduate or post-graduate, professional, and pure and applied science courses - may claim deduction. The deduction will be available for a maximum of eight years starting from the day you start repaying the education loan.
6. Donations to a charity - Section 80G – All donations to specific charitable organizations such as the Prime Minister's Relief Fund, CARE and Help Age India are eligible for a 100 percent tax relief. Donations to other charitable institutions and trusts get only 50 per cent tax relief.
7. Other Deductions - Under Chapter VI , there are also other deductions available for handicapped people and medical treatment of disabled dependents (up to Rs.50,000). Also, deduction for medical treatment for specified diseases such as neurological diseases, cancer, AIDS and hemophilia are allowed up to Rs.40,000 for individuals and Rs. 60,000 for senior citizens.
There are other deductions also available on certain other expenses, but since they are not applicable to most tax payers in India, I have not mentioned them. After deducting all the above mentioned investments and expenses from your total gross income, you are left with your 'Net Taxable Income'. The next post will provide information on the tax slabs and tax calculation on net taxable income for different categories of people such as male salaried individuals, women and senior citizens.
Did you find this section on the best deductions to reduce income tax for salaried individuals in India helpful? Do you have any other tips or information to add?
Here are my other posts on calculating Income Tax in India
Deducting Office Allowances and Reimbursements
Deducting Investments and Expenses