In today’s post I am talking about Personal Income Tax liability and various options available to an individual to invest (not save) and get a tax break.

I am sure everyone is well versed with the tax slabs for FY’15-16. The slabs are as below:

Tax Rate FY 2015-16
Nil Upto Rs.250000
10% Rs. 2.5 lacs to 5 lacs
20% Rs. 5 to 10 lacs
30% Above Rs.10 lacs

Deduction / Tax Break is available for savings / investments under section 80C up to Rs.1.5 lacs. i.e. one can get tax breaks up to this amount.

Please be aware that the same principle, “Is my money working as hard as me” applies here as well.

I have come across so many people who have invested just for the sake of saving taxes. This normally happens between Jan – March in a huge rush and one ends up allocating hard earned money in poor yielding instruments (normally traditional Life Insurance or ULIP like schemes).

Please refer to templates / trackers I shared in my previous articles:

  1. Monthly Income & Deductions to forecast your tax liability &
  2. Fixed Expense Planner to forecast allocation for tax savings / investments.

The options for tax savings / breaks are:

  • EPF & VPF – Employee Provident Fund & Voluntary Provident Fund
  • PPF – Public Provident Fund
  • ELSS – Equity Linked Savings Scheme
  • NSC
  • Bank Deposits >5 yrs
  • Life Insurance Premiums
  • Pension Policy Premium
  • Pension Scheme of Mutual Funds

Principal of Home Loan & School / College Fees

I am a fan of top 3 options only. The rest are not highly recommended. The table below provides the answer why in addition to tax implications & other details.

Investment Returns Taxation Lock in period
1 EPF / VPF 8.5% Tax free after 5 years 5 years
2 PPF 8.6% Tax free Partial withdrawal after 6 yrs,

 

Complete withdrawal after 15 yrs
3 ELSS Based on market perf.

12-15% over long term

 Tax free 3 yrs
4 NSC 8% Taxable as per your slab 6 yrs
5 Bank Deposits 6-9.5% Interest taxable as per your slab Tenure dependent
6 Life Insurance Premiums Traditional policies 4-6%

Guaranteed funds may give slightly higher

ULIPs based on market perf

Term plan – no maturity value

 Tax free Traditional policies for tenure

 

ULIP – 5 yrs onwards
7 Pension Policy Premium Traditional Policy 4-6%

ULIP based – market linked

 Taxable 5-6 yrs
8 Pension scheme of MF Based on market perf

8-10% over long term

 Varies Until retirement

Another piece one must focus on is the tax benefit v/s opportunity cost. Example, home loan repayments help you save taxes. True but evaluate the cost benefit of taking a loan just to save taxes.

If an individual takes a home loan of Rs.75 lacs at 9.8% interest. The Interest cost for the first year will be almost Rs.7.5 lacs.

Tax break is available for Rs.2.5 lacs only. Assuming the individual is in 30% tax bracket, he/she effectively saves only Rs.75000/- in tax liability. i.e. 30% of Rs.2.5 lacs.

So one’s interest cost for the year is Rs.6.75lacs. So the cost of acquiring the house has gone up by 9% at end of year one. Are property prices going up by the same rate? I am not sure.

Rent for the same house will be just Rs.20000/- per month (assuming 2-2.5% annual rental yield).

Hope this helps you get started on allocating amounts for tax benefit (please investments not savings).

Compounding & Time– The secret magic for your investments – Sept 21, 2015

Following up from my last article on Tax Saving (Investments) options this one touches upon the power of “Compounding”.

It is believed that Einstein considered Compounding as the Eighth Wonder of the world. I am not sure if Einstein really said this or people have just made this up. However, this does not take away the fact that “Compounding” indeed deserves this title.

Some simple examples will prove this claim.

Let’s start with 2 of the investments / savings options I recommended in my previous article:

  1. Public Provident Fund
  2. ELSS

Now, let’s take an example where a 35 year old invests Rs.50000/- (about Rs.4200/- a month) in a PPF scheme for 15 year. Then he leaves the amount untouched for another 10 years without making any contributions. The scheme typically provides say a 8.6% returns.

This will be his corpus after 25 years:

Start age 35 years
Investment per year Rs.50000/-
Investment years 15 years (i.e. until age of 50)
Acct extended for 10 years Until age 60
Interest rate assumed 8.6%
Amount Invested Rs.7.5 lacs (50000*15)
Maturity value after 25 years Rs.32.5 Lacs
Tax free interest earned Rs.24.96 lacs

Isn’t that a great sum – making a sum of almost 25 lacs on an investment of just Rs.7.5 lacs.

Now let’s see what a marginal difference of 3.6% additional earning (12% v/s 8.6%) can do to the same investment.

Suppose the individual invested in an ELSS scheme which typically would give a 12% return over long term.

Start age 35 years
Investment per year Rs.50000/-
Investment years 15 years (i.e. until age of 50)
Acct extended for 10 years Until age 60
Returns assumed 12%
Amount Invested Rs.7.5 lacs (50000*15)
Maturity value after 25 years Rs.64.8 Lacs
Tax free returns Rs.57.33lacs

Just a mere 3.6% point higher return translates into the amount “Doubling”.

If the returns were 15%, the value would be over 1 crore.

And folks this is not an “excel ka kamaal”. Business / entrepreneurs create wealth by achieving extra ordinary growth rates over time. So when you invest directly (stocks) or indirectly (mutual funds), you stand to gain a bit of that pie.

And once again creating wealth is not a 100 meter dash, it’s a marathon.

Spend the time in the market & don’t time the market to let “Compounding” work its wonders on your investments…