So what will it be, life insurance policy or public provident fund (PPF)? The Finance Bill 2014 presented in the Union Budget last week has given you Rs 50,000 more to save in section 80C products, hiking the tax deduction limit to Rs 1.5 lakh.
This extra deduction means savings of around Rs 5,000 on taxes if you are in the 10.3% tax bracket, and around Rs 15,000 for those in the highest tax bracket of 30.9%. A deduction is the first tool to use to reduce your tax liability. A hike in deduction is good news as it not only lets you save on taxes but also incentivises investments in the section 80C basket, which has some good options. So, which of these should you choose?
The 80C basket
In terms of investments, the 80C basket comprises a whole host of products—seven investment vehicles (PPF, Employees’ Provident Fund or EPF, equity-linked savings scheme or ELSS, premiums paid towards life insurance, National Savings Certificate or NSC, Senior Citizens Savings Scheme or SCSS, and five-year term deposits in banks and post office). Other than these, the 80C basket also includes tuition fees and the principal repayment of a home loan.
In case of 80C investments the initial contribution, interest earned or maturity proceeds are all tax-free. For NSC, the initial contributions and the interest that accrues every year and gets reinvested qualifies for 80C deduction. But on maturity, the interest income is taxed at your marginal rate. In case of SCSS and term deposits, the interest income is also taxable. Other than these products, pension plans under section 80CCC and 80CCD also qualify for a tax deduction.
However, it appears that the deduction limit on these vehicles has been retained at Rs 1 lakh. “The rationale seems to be to align the tax treatment on all pension products,” said Sonu Iyer, partner and national leader, human capital services, EY.
Stick to the basics
The first step is to cut out the noise, and focus on your goals and asset allocation. “Insurance comes first and a term plan is the best option. But most people exhaust a big section of the 80C limit by buying investment plus insurance plans. If there is more scope, we look at the existing asset allocation and time horizon for holding the investments to decide between investing in equity or debt asset,” said Nikhil Vikamsey, partner, Alpha Capital.
“Unit-linked insurance plans (Ulips) have transformed and can’t be ruled out, but it’s better to keep the needs of insurance and investment separate,” said Suresh Sadagopan, founder, Ladder7 Financial Advisories.
Eye on the goal
After insurance come the goals and time horizons. “Section 80C products are not about tax savings alone. If the investor understands equity risk, wants returns and a shorter lock-in period, then ELSS is a good option. But for the risk-averse or investors who don’t mind longer lock-in, PPF is a good bet,” said Sadagopan. “ELSS is not appropriate because it is affecte dby market volatility; you may prefer a fixed deposit instead,” he added.
EPF is now mandatory for employees having a basic salary of up to Rs 15,000 per month. For those earning above that limit, the contribution is voluntary. The 12% that you contribute qualifies for tax deduction under section 80C of up to `1.5 lakh now. If you encash your EPF after five years, the proceeds are tax-free.
For the last fiscal, the declared EPF interest rate was 8.75%. For salaried individuals, EPF is a good long-term investment vehicle, especially for retirement. NPS is a low-cost, market-linked product that allows you to invest every year in funds of your choice. But, being a new product, financial planners don’t recommend a high allocation to it.
The PPF route
The next is the PPF, which is a 15-year product making it an attractive for the long-term. The returns are market-linked now and pegged to the average government securities yield of similar maturity. For the current and the previous fiscals, the rate has been declared at 8.7%. You can, in fact, use up the entire section 80C limit through PPF alone. “Even for young individuals, PPF is a good as it helps achieve long-term goals,” said Manikaran Singal, founder, Good Moneying Financial Solutions.
Use products with longer lock-in periods, such as PPF, EPF and NPS, for long-term goals. For short-term goals or for investment options for senior citizens, you could choose fixed deposits and SCSS. For equity exposure, look at ELSS. But before all this comes insurance.