Tax saved is money earned
Power saved in power generated
It applies to money too. Many of us will be paying tax. Government proposes some ways to reduce the tax payable by individuals. They all come under a single umbrella - investments. You can invest upto Rs 1 lakh and claim for tax exemption. Using this, you can save upto Rs30,000/ per year.
Why do government allow us to reduce tax?
This is one of the most common questions. For reducing tax, you should invest your money somewhere in the market. This encourages savings among the people. This also reduces the amount of money that will sleep under your carpet. This increases the cash-flow in the country. If we invest the money in public sector companies, this will also help the company's operating capacity, there by improving the overall economy.
Let us look at the various ways of investments. Some investments provide tax benefits and others do not.
Banks
Most banks provides an interest at the rate of around 6% depending on various schemes. But there is no tax excemption for investments in bank. So if you keep your Rs1 lakh in your savings account, you will earn 6% at the end of the year, ie Rs 6000/. It looks your money has increased in its value. But what you see may not be the truth.
The tax you will be paying varies from 10% or 20% or 30 % depending on the tax slab you fall. That is minimum tax you should have payed is Rs 10,000/. That is you have lost around 4% of your money. Now consider the inflation, the value of your money has really gone down a lot.
But if you reinvest the interest you earned, then the money will get compounded, annually. If you can invest Rs 10,000/ annually for 15 years, reinvesting the interests, (assuming a rate of interest of flat 6%) , you would receive Rs 2,46,725/ at the end of 15 years. The total tax you would have payed is 10% of Rs10000 per annum i.e. 15*10000 = 15,000/. Hence a overall profit of Rs2,31,725/.
Insurance
Life Insurance is one of the most important investment that any individual should have. You need not consider it as a tax saving plan. You can consider it as both tax saving and as risk coverage. So first step towards investments for long term should be Life Insurance. I will always choose Life Insurance Corporation of India (LIC) only. But there are other private insurance agencies too. All these have their own pros and cons. Read the rules and conditions completely before choosing the agency.
LIC : Jeevan-Anand
The scheme I have invested in, is 'Jeevan - Anand' from LIC.
At the end of the premium paying term the full sum assured will be returned along with the bonus. There was lots of calculations for calculating bonus. But this is approximately 7-8% compounded, annually. Also the risk cover will continue after the premium payment term. There are lots of other benefits also. Insurance also has tax benefits.
ING Vysya
The other scheme that I considered is from ING-Vysya. I don't remember the exact scheme name, but it is also alomost similar to Jeevan-Anand scheme of LIC. The interest rate is apporoximately 10%. This will give a very good profit. But there is a catch. At the end of the premium payment, you wont get the accumilated bonus. It will be given to you at the age of 85 or in case of your death, whichever occurs first. But if you want the bonus money at the end of the premium payment term, you can cancel the risk cover and get all the accumilated bonus and the sum assured. That is you will lose the risk cover, which is the most important use of Life Insurance.
You can also check other schemes before investing, but get a complete picture about that particular scheme. I prefer, you should always invest some money in Life Insurance before starting to invest in other types of investments. Risk handling is the most important task every where. In my opinion, you should have a policy for a minimum amount of twice your annual income. This also depends on your personal liabilities. For example, if you have an younger sister, you should save some money for her marriage, and many such reasons are there. But never skip insurance.
Public Provident Fund (PPF)
A PPF is a long-term savings plan with attractive tax benefits. Interest is given at the rate 8 % per annum, compounded annually. You can vary the amount you are investing on PPF depending on your need. There is a minimum of about Rs 100/ you should invest every year.
The money will be locked for 15 years. The lump sum you will earn at the end of 15 years is not taxable. Learn more about the PPF and its various advantages and disadvantages, here.
If you invest Rs 10000 every year, at the end of 15 years, you will get Rs 2,93,242/. For Rs1000 per year, you will receive Rs29,324/.
When compared to the bank investment where you get Rs2,46,725/, you will get around 50,000 more. This may not look very attractive when compared to the advantage of banks (withdrawing money whenever you want - late nights, sundays, thanks to ATMs) . But still this increases the profit. By keeping some amount of money in bank and investing other in PPF will get you a good profit without losing the advantage of Banks.
Till now, we havent considered the most important advantage of PPF - Tax Savings. The amount of tax you save, depends on the tax slab you fall. Let us consider your tax rate is 10%.
In the first year, you invest Rs 10000/ in PPF. You will get a tax benefit of Rs1000/. You can reinvest the tax benefit you received in the next year. i.e Rs 1000/ + Rs 10000 = Rs 11000/. From the second year, you can invest Rs 11,000 every year. Then, at the end of 15 years, you will get Rs3,19,394/. This is a great sum of money that you will be receiving. Compare it with the bank alternative. You have received around Rs85,000/ without doing any work on your own, without spending any additional time. Great right?
If you are in 30% tax slab, then the total money you will get at the end of 15 years will be around Rs3,71,698/ But in bank, you will get a little above Rs 2 lakh. A great profit of Rs1,71,698/
The main disadvantage of PPF is the total time period, i.e 15 years. One more thing, you should invest atleast Rs100/ every year to keep you account active.
Even if you feel that the PPF returns in low and the time frame is too long to wait, and you are ready to take more risk like investing in ELSS, etc, my advice is to have a PPF account and deposit atleast the minimum amount. Initially, it may not help saving tax, but later, say after 8 years, you feel that you should reduce the risk, you are free to make use of this PPF account. Now the actual lock period is just 15-8 = 7 years. At the end of say 14th year, you have money, but you know that you will need it soon in another 1-2years, but you want to save tax, you can simply invest in this PPF account. So the lock period is just 1-2more years and you have cut your tax. So, If you feel that Rs100/ is too less only, go to the nearest post office, open a PPF account and invest Rs100/- The return you will get with this 100/ is too less. The tax benefit that you will get is also too less. But in a long term, that is after 10years, the account you have is more valuable.
National Savings Certificate (NSC) Bonds:
NSC Bonds are another good investment. Similar to PPF, NSC Bonds should also be obtained through Post Office. NSC Bonds provide an annual interest rate of 8% that is compounded semi- annually, with a lock-in period of 6years. That is, if you invest Rs1000/, you will get a Rs1601/ at the time of maturity. But the interest you get is taxable. So, after 6years, if you fall in the 10% taxslab, you will get Rs1541/ after tax. You will get Rs 1420/ if you fall in 30%taxslab.
Assume the situation (most common for IT professionals). Today, you fall in 10% taxslab. You invest Rs1000 in NSC Bonds. After six years you fall in 30%taxslab. Then, the net profit after 6years in 1520/ By adding the tax saved also.
Advantages of NSC over PPF are: The shorter lockin period. The interest rate compunded semi-annually. The interest rate is fixed. In PPF govt may increase the interest rate, or reduce the interest rate every year. But the disadvantage is, the interest that we gain, is taxable.
My advise is to have some investments in NSC and some in PPF to take the advantage of the chances of increasing interest rate.
Housing Loan:
Once upon a time, getting loan was a prestige issue. Now it is almost a fashion. Using credit cards to show their royalty, getting everything in loans, etc. But even during the olden days, for construction house people used to use their money in hand and also borrow some part from some money lenders. Now-a-days, most banks gives loans very easily. The total loan amount you will get mostly depends on your annual income. Government also provides tax exemptions for the amount you repay for housing loans. If you decide to get a loan for Rs 10 lakh, with a monthly repayment of Rs50000/ then you will be in debt for 20 years. Do all such calculations before deciding to get a loan. If you are constructing a house with a plan to let it for rent, then consider the amount of rent you will get also. Make sure that the rent you get is nearly equal to the annual repayment for loan. Usually, the rent you get may be low, but this gets componsated with the inflation and the increase in the land price.
The tax you save will not be enough for the interest you are paying for the loan. Consider this case also. You should get the house loan only if your intention is to have a new house. This is not an option just to save tax. Tax saving is just a benefit that you can avail in getting a house loan.
Equity Linked Savings Scheme (ELSS):
Equity Linked Savings Scheme(ELSS) also called Tax-Saving Mutual Funds are good place for you to invest and to save tax. But unlike PPF or Bonds, Mutual Funds does not have a fixed interest rate. That is Rs10000/ you invest today may be 50,000 in 3years or 5000/ in 3years. Nothing is guaranteed. But in past 3years, most mutual funds make a compounded annaualised gain of around 90%. That is Rs10,000 became Rs 68,590/ in 3years. You can't expect the same return always. But in the past 10-15 years, most of the mutual funds made a compounded annualised return around 30-40%. That is Rs 10000/ you invested became Rs21000/ to Rs27000/
But this is also history. History may not repeat. Nothing is guaranteed. But if your risk appetite is more, you can invest on ELSS for more returns and a better capital appreciation. One more advantage in ELSS is that the minimum lock-in period is just 3 years.
To have look at the various tax saving mutual funds and their returns, click here.
Now consider the tax saved and reinvest in the tax saving mututal funds, and calculate its worth after 3 years.
Summary:
There are various ways to save tax, and there by increase you net worth in a long term. You can make use of these various investment instruments, you can also make a mix of all these investments to increase the profits at the same time reduce the risk involved.
There is no single best investment instrument. Each has its own pros and cons, risks and benefits. It all depends on the individuals risk appitite, family commitments, etc .
Research about various investment options before you invest.
It applies to money too. Many of us will be paying tax. Government proposes some ways to reduce the tax payable by individuals. They all come under a single umbrella - investments. You can invest upto Rs 1 lakh and claim for tax exemption. Using this, you can save upto Rs30,000/ per year.
Why do government allow us to reduce tax?
This is one of the most common questions. For reducing tax, you should invest your money somewhere in the market. This encourages savings among the people. This also reduces the amount of money that will sleep under your carpet. This increases the cash-flow in the country. If we invest the money in public sector companies, this will also help the company's operating capacity, there by improving the overall economy.
Let us look at the various ways of investments. Some investments provide tax benefits and others do not.
Banks
Most banks provides an interest at the rate of around 6% depending on various schemes. But there is no tax excemption for investments in bank. So if you keep your Rs1 lakh in your savings account, you will earn 6% at the end of the year, ie Rs 6000/. It looks your money has increased in its value. But what you see may not be the truth.
The tax you will be paying varies from 10% or 20% or 30 % depending on the tax slab you fall. That is minimum tax you should have payed is Rs 10,000/. That is you have lost around 4% of your money. Now consider the inflation, the value of your money has really gone down a lot.
But if you reinvest the interest you earned, then the money will get compounded, annually. If you can invest Rs 10,000/ annually for 15 years, reinvesting the interests, (assuming a rate of interest of flat 6%) , you would receive Rs 2,46,725/ at the end of 15 years. The total tax you would have payed is 10% of Rs10000 per annum i.e. 15*10000 = 15,000/. Hence a overall profit of Rs2,31,725/.
Insurance
Life Insurance is one of the most important investment that any individual should have. You need not consider it as a tax saving plan. You can consider it as both tax saving and as risk coverage. So first step towards investments for long term should be Life Insurance. I will always choose Life Insurance Corporation of India (LIC) only. But there are other private insurance agencies too. All these have their own pros and cons. Read the rules and conditions completely before choosing the agency.
LIC : Jeevan-Anand
The scheme I have invested in, is 'Jeevan - Anand' from LIC.
At the end of the premium paying term the full sum assured will be returned along with the bonus. There was lots of calculations for calculating bonus. But this is approximately 7-8% compounded, annually. Also the risk cover will continue after the premium payment term. There are lots of other benefits also. Insurance also has tax benefits.
ING Vysya
The other scheme that I considered is from ING-Vysya. I don't remember the exact scheme name, but it is also alomost similar to Jeevan-Anand scheme of LIC. The interest rate is apporoximately 10%. This will give a very good profit. But there is a catch. At the end of the premium payment, you wont get the accumilated bonus. It will be given to you at the age of 85 or in case of your death, whichever occurs first. But if you want the bonus money at the end of the premium payment term, you can cancel the risk cover and get all the accumilated bonus and the sum assured. That is you will lose the risk cover, which is the most important use of Life Insurance.
You can also check other schemes before investing, but get a complete picture about that particular scheme. I prefer, you should always invest some money in Life Insurance before starting to invest in other types of investments. Risk handling is the most important task every where. In my opinion, you should have a policy for a minimum amount of twice your annual income. This also depends on your personal liabilities. For example, if you have an younger sister, you should save some money for her marriage, and many such reasons are there. But never skip insurance.
Public Provident Fund (PPF)
A PPF is a long-term savings plan with attractive tax benefits. Interest is given at the rate 8 % per annum, compounded annually. You can vary the amount you are investing on PPF depending on your need. There is a minimum of about Rs 100/ you should invest every year.
The money will be locked for 15 years. The lump sum you will earn at the end of 15 years is not taxable. Learn more about the PPF and its various advantages and disadvantages, here.
If you invest Rs 10000 every year, at the end of 15 years, you will get Rs 2,93,242/. For Rs1000 per year, you will receive Rs29,324/.
When compared to the bank investment where you get Rs2,46,725/, you will get around 50,000 more. This may not look very attractive when compared to the advantage of banks (withdrawing money whenever you want - late nights, sundays, thanks to ATMs) . But still this increases the profit. By keeping some amount of money in bank and investing other in PPF will get you a good profit without losing the advantage of Banks.
Till now, we havent considered the most important advantage of PPF - Tax Savings. The amount of tax you save, depends on the tax slab you fall. Let us consider your tax rate is 10%.
In the first year, you invest Rs 10000/ in PPF. You will get a tax benefit of Rs1000/. You can reinvest the tax benefit you received in the next year. i.e Rs 1000/ + Rs 10000 = Rs 11000/. From the second year, you can invest Rs 11,000 every year. Then, at the end of 15 years, you will get Rs3,19,394/. This is a great sum of money that you will be receiving. Compare it with the bank alternative. You have received around Rs85,000/ without doing any work on your own, without spending any additional time. Great right?
If you are in 30% tax slab, then the total money you will get at the end of 15 years will be around Rs3,71,698/ But in bank, you will get a little above Rs 2 lakh. A great profit of Rs1,71,698/
The main disadvantage of PPF is the total time period, i.e 15 years. One more thing, you should invest atleast Rs100/ every year to keep you account active.
Even if you feel that the PPF returns in low and the time frame is too long to wait, and you are ready to take more risk like investing in ELSS, etc, my advice is to have a PPF account and deposit atleast the minimum amount. Initially, it may not help saving tax, but later, say after 8 years, you feel that you should reduce the risk, you are free to make use of this PPF account. Now the actual lock period is just 15-8 = 7 years. At the end of say 14th year, you have money, but you know that you will need it soon in another 1-2years, but you want to save tax, you can simply invest in this PPF account. So the lock period is just 1-2more years and you have cut your tax. So, If you feel that Rs100/ is too less only, go to the nearest post office, open a PPF account and invest Rs100/- The return you will get with this 100/ is too less. The tax benefit that you will get is also too less. But in a long term, that is after 10years, the account you have is more valuable.
National Savings Certificate (NSC) Bonds:
NSC Bonds are another good investment. Similar to PPF, NSC Bonds should also be obtained through Post Office. NSC Bonds provide an annual interest rate of 8% that is compounded semi- annually, with a lock-in period of 6years. That is, if you invest Rs1000/, you will get a Rs1601/ at the time of maturity. But the interest you get is taxable. So, after 6years, if you fall in the 10% taxslab, you will get Rs1541/ after tax. You will get Rs 1420/ if you fall in 30%taxslab.
Assume the situation (most common for IT professionals). Today, you fall in 10% taxslab. You invest Rs1000 in NSC Bonds. After six years you fall in 30%taxslab. Then, the net profit after 6years in 1520/ By adding the tax saved also.
Advantages of NSC over PPF are: The shorter lockin period. The interest rate compunded semi-annually. The interest rate is fixed. In PPF govt may increase the interest rate, or reduce the interest rate every year. But the disadvantage is, the interest that we gain, is taxable.
My advise is to have some investments in NSC and some in PPF to take the advantage of the chances of increasing interest rate.
Housing Loan:
Once upon a time, getting loan was a prestige issue. Now it is almost a fashion. Using credit cards to show their royalty, getting everything in loans, etc. But even during the olden days, for construction house people used to use their money in hand and also borrow some part from some money lenders. Now-a-days, most banks gives loans very easily. The total loan amount you will get mostly depends on your annual income. Government also provides tax exemptions for the amount you repay for housing loans. If you decide to get a loan for Rs 10 lakh, with a monthly repayment of Rs50000/ then you will be in debt for 20 years. Do all such calculations before deciding to get a loan. If you are constructing a house with a plan to let it for rent, then consider the amount of rent you will get also. Make sure that the rent you get is nearly equal to the annual repayment for loan. Usually, the rent you get may be low, but this gets componsated with the inflation and the increase in the land price.
The tax you save will not be enough for the interest you are paying for the loan. Consider this case also. You should get the house loan only if your intention is to have a new house. This is not an option just to save tax. Tax saving is just a benefit that you can avail in getting a house loan.
Equity Linked Savings Scheme (ELSS):
Equity Linked Savings Scheme(ELSS) also called Tax-Saving Mutual Funds are good place for you to invest and to save tax. But unlike PPF or Bonds, Mutual Funds does not have a fixed interest rate. That is Rs10000/ you invest today may be 50,000 in 3years or 5000/ in 3years. Nothing is guaranteed. But in past 3years, most mutual funds make a compounded annaualised gain of around 90%. That is Rs10,000 became Rs 68,590/ in 3years. You can't expect the same return always. But in the past 10-15 years, most of the mutual funds made a compounded annualised return around 30-40%. That is Rs 10000/ you invested became Rs21000/ to Rs27000/
But this is also history. History may not repeat. Nothing is guaranteed. But if your risk appetite is more, you can invest on ELSS for more returns and a better capital appreciation. One more advantage in ELSS is that the minimum lock-in period is just 3 years.
To have look at the various tax saving mutual funds and their returns, click here.
Now consider the tax saved and reinvest in the tax saving mututal funds, and calculate its worth after 3 years.
Summary:
There are various ways to save tax, and there by increase you net worth in a long term. You can make use of these various investment instruments, you can also make a mix of all these investments to increase the profits at the same time reduce the risk involved.
There is no single best investment instrument. Each has its own pros and cons, risks and benefits. It all depends on the individuals risk appitite, family commitments, etc .
Research about various investment options before you invest.
posted by Jayaprabhakar | 2:17 PM
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