When I started on my first job, I didn’t know much about income taxes and how to save money on paying it. So I let my Dad to handle all my tax savings. There were many mistakes that were made as a result of that.

Buying traditional LIC policies

Technically my dad can’t be blamed for taking these LIC policies. Because thats what he did when he started earning. During those times Life Insurance Corporation of India was the only company which provided life insurance and it was the only way to save a bulk on your income tax.

That is no longer true as there are numerous other companies which provide Term Life Insurance with quite a large amount of life cover at very low prices. Spending almost Rs.45,000 per year on LIC policies to get the 80C deductions is a complete waste of money.

At least my dad invested in 5 separate policies in a staggered manner (one every year) and they were money back policies. So every year one policy will return back a portion of the money invested. This reduced the amount of outgo every year, as the cheque I receive from LIC will pay a part of the premium every year. This is much better than the endowment policy which gives your money only at the end of the term.

Investing in ULIP

ULIPs are a very bad form of investment/insurance. It is evident with all the mis-selling that were done by the brokers and SEBI finally putting in more rules. Rs.5000 was put in a Unit Linked Insurance Policy by UTI because my dad’s friend suggested it. The amount I paid every year and the life cover & returns that I got wasn’t worth it.

Both the insurances I had bought returns less than what inflations eats from my savings. Must’ve opted for term insurance and skipped all the other forms of insurances.

Investing in ELSS funds in bulk at the same time

ELSS or Tax saving Mutual Funds allow you to invest in equity and also save tax. The only restriction is a lock-in period of 3 years. I invested in about 5 ELSS funds in the end of year 2007 for a huge amount.

While investing in equities is a good thing, I made three mistakes here:

1. Invested just when the market was touching its all time highs.
2. Putting all the money at the same time. The goal I had was to save taxes – not invest the money.
3. Investing in 5 funds is a bit too much. Especially when all 5 were ELSS funds and almost had the same goals. I didn’t diversify in the right way.

Result? The returns I received was dismal. Even though NIFTY/Sensex is back to its highs, the funds haven’t reached the old NAVs. Meaning I am still in negative.

Tomorrow I will write how I could have done a better job in the Mutual Funds by using something called SIP (Systematic Investment Plan).

Many employees would have heard from their HR or finance department asking to give details about investments made under 80C. So what is this 80C? Let me explain with an example.

Lets say you earn Rs. 5 lakhs salary per year. For upto Rs. 2 lakh, you don’t have to any tax. That means, you would have to pay 10% of the amount which exceeds Rs. 2 lakhs, i.e., 10% of 3,00,000 = Rs. 30,000. You have to pay Rs. 30,000 as the income tax for the financial year.

Now lets assume you invested some money (Rs. 1,00,000 which is the max) which come under the section 80C of Income Tax Act, this entire money is now tax deducted. Meaning, you will have to pay the 10% of just Rs. 2 lakh = Rs. 20,000. You save Rs.10,000 on your tax bill. You already invested Rs. 1 lakh in some investment product + you also save an extra Rs. 10,000 (which would have gone to the government). How cool is that?

Investment Options under 80C

Now you may ask what are the options one has to invest under 80C. Here is a list.

PF/EPF – Employee Provident Fund: Employers (having more than 20 employees) should deduct a percentage of your salary and deposit in your name in a EPF account. This deduction is counted against 80C and you can use the same account even if you switch companies. All the money they put in here will grow and be useful when you retire in the far future. The best part is the interest you earn is also tax free.

PPF – Public Provident Fund: Any person can open a PPF account in SBI or ICICI bank or post office and deposit money in it every year. It is useful if you work for yourself or you work for a very small company. It must be maintained for a minimum of 15 years and can be extended by 5 years after it matures. Minimum contribution is Rs. 500 and Maximum contribution is Rs. 1 lakh per year. And it earns 8.7% which is also tax free like EPF.

NSC – National Savings Certificate: You can purchase National Savings Certificate from any post office or online in some banks. Period of NSC is either 5 or 10 years and it earns an interest rate of 8.5% as of today.

But remember, the interest you earn through this is considered an income and will be taxed separately every year. You can however choose to reinvest it again.

5 year Bank Fixed Deposit: Banks have a fixed deposit which can be used for tax saving purpose which has a term of 5 years. It would earn somewhere around 8.5-9.5% depending on the bank. The money you put in will be locked in for 5 years and can’t be prematurely withdrawn. The interest earned is taxable.

5 year Post office Time Deposit: Just like banks, post offices too have fixed deposits called Time Deposit. The 5 year term plan has tax savings benefit and earn 8.4% interest. The interest is taxable.

National Housing Bank Suvriddhi: NHB also has term deposits for 5 years which has tax benefits. It earns 9.25% interest rate and has a minimum deposit of Rs. 10,000 or multiple of it.

Life Insurance Premium: Any premium you pay for life insurance can be claimed under 80C for tax saving purpose. This is the main reason people take endowment policies which has huge premiums and very little cover. But after April 1, 2013, only premium equal to 10% of sum assured will be allowed under 80C. So you can’t pay Rs.50,000 premium for just Rs. 1 lakh insurance cover.

My suggestion as mentioned in a post before is to take a term insurance and invest the remaining money in the other options which earn a better return.

ULIP – Unit Linked Insurance Plan: This is another life insurance product, but your money would be primarily invested in the equity market. So if the equity market performs well, you would get better returns. If not, you money can be lost. It is not advisable to invest in ULIPs as you should never mix investment and insurance.

Pension Fund: There are a few pension funds (LIC or other private insurers) which can give tax relief for the financial year. This comes under the section 80CCC, which is part of the 80C when it comes to the calculation of the Rs. 1 lakh limit.

NPS – National Pension Scheme: Money invested in NPS in Tier 1 scheme is deductible from Income Tax under the 80CCD section. But the aggregate deduction from 80C, 80CCC and 80CCD can’t exceed Rs. 1 lakh. So if you have already invested in other products, there isn’t much you can do here.

ELSS – Equity Linked Savings Scheme: This is a mutual fund schemes which has a lock-in period of 3 years (the lowest lock-in period) that is approved for tax savings. Your money invested in ELSS funds are invested in the equity market and you would get better returns if the market performs well. It is risky, but if invested properly and in the long run it can earn better returns.

Another good news is any dividend you earn is tax free and also if the market doubles or triples your investment in 3-5 years and you take all your money out, you don’t have to pay even a single Rupee as tax. Any equity invested for more than 1 year comes under long term capital gains which has no tax.

Tuition Fees: If you have kids going to school or college, the tuition fees paid for their education is tax deductible.

Home loan Principal Repayment: If you take a home loan, you can claim the principal paid every month for tax deduction under 80C. Do note that only the principal can be claimed under 80C and during the initial years of the loan repayment, you would be paying most of the interest. Only during the later stages you would be paying more of principal and less of interest.

Stamp Duty & Registration Charges for Home: If you bought a house, you would have paid stamp duty and registration charges. You can claim this under 80C if you bought it in that financial year.

Why save tax?

You might be wondering why I am asking you to save tax rather than investing in high yielding products and becoming a millionaire. Money can’t grow suddenly, it grows slowly and exponentially if done the right way. But before that, we need to make sure that we make sure that we reduce our tax bill as much as possible.

Section 80C has excellent investment opportunities which also helps you save tax. This extra Rs. 10,000 you save on taxes every year can be invested properly and earn you a nice extra money when you retire. Or you may choose to use that money to go for a trip. It depends on you. But remember, any money you can save is money you earn.

Which option to choose?

Now you might think which of the following options are better? Remember, there are a few products in there which are risky like ELSS and ULIP and others which are very safe like PPF, bank deposits, etc. Also remember the returns you can earn is directly proportional to the risks you take.

The first investment you should make is buying a term insurance. Lets say the premium is Rs. 10,000 for a sum assured of Rs. 1 Crore. The remaining Rs. 90,000 should now be invested in partially in risk free products and partially in risky products. So that overall the risk is mitigates and your returns are higher than sticking to a risk free product.

Lets take an example: Your company deposits Rs. 20,000 as EPF and you have a term insurance with premium of Rs. 10,000. You have Rs. 70,000 to invest. You can now invest about Rs. 40,000 in ELSS, buy a 5 year term deposit for Rs. 10,000, if you have a kid you can claim the tuition fees and also claim the loan repayment for your new apartment. Overall if you add all your investments make sure you reach the goal of maximum Rs. 1,00,000 so that you gain the maximum benefit.

Now you may be wondering how splitting the money into different products help you. Its called portfolio diversification and lets see that in tomorrow’s post.

P.S.: Want to know why the government provides tax relief for these investments? Because these investments help growing the economy of the nation in some way or the other. Be it investing in the equity market (long term) or education of your children or building news houses – they all contribute in some way to the making the nation better. So the government gives tax benefits for these investment.

P.P.S: Also don’t think of these as evading tax. You are actually saving tax and in the most legal way. Also helping to make your country better. You getting more money out of your investment is an added benefit.