ELSS offers an excellent combination of a shorter lock-in, market-linked returns, and greater flexibility, thus making it an ideal choice.
With March 31 just a fortnight away, those who have not done their tax-saving investments
yet would be rushing to do so. With such procrastination till the very last moment, there is always the risk that the investor could end up selecting the wrong tax-saving instrument. It’s important to keep a variety of criteria—return, lock-in, your risk appetite, investment
horizon, etc—in mind when choosing your tax-saving investment.
Ideally, your tax-saving investments
should be in sync with your long-term financial planning. The investments
you make should also enable you to meet life’s expected and unexpected expenses. They should also enable you to plan for a graceful and comfortable retirement. Thinking of tax planning and retirement planning as mutually exclusive is not the right approach. Remember that tax-saving should be an additional perk and not the end goal.
The best tax-saving option
Several dedicated tax-saving products are available that you can choose from. You have fixed deposits (FDs), Employee Provident Fund (EPF), Public Provident Fund (PPF), National Savings Certificate (NSC), and Equity-linked Savings Scheme (ELSS). While most investors have a good understanding of fixed-income instruments like EPF, PPF, and NSC, and are comfortable investing in them, they often shy away from investing in ELSS, which is a market-linked instrument. Let us examine a couple of options in detail and compare them with ELSS to understand the potential that the latter holds, not just for tax saving
but also for a long-term goal like retirement planning.
It is a popular investment
option as it enjoys the EEE (exempt-exempt- exempt) tax status. This means that the principal you have invested, the interest you have earned, and the maturity amount are all exempt from tax. The interest rate on it is 7.9 per cent currently. From the tax planning point of view, it has a lot to offer, but when you look at it from the long-term financial planning perspective, the benefit is limited. PPF investment comes with a 15-year maturity. If you were to invest in a market-linked product for the same tenure, past data shows that you would accumulate a much larger sum. However, if you have built a long-term, asset-allocated portfolio and need an instrument for the fixed-income portion, PPF fits the bill.
They are the go-to option for many. While tax-saving FDs come with a lock-in period of five years, they offer returns in the range of 6-8 per cent. Again, the same amount invested in a market-linked tax saving
product like ELSS will enable you to accumulate a much larger sum.
Ulips and insurance plans:
They are often sold as a way to save tax as well as get insurance coverage. Unit-linked insurance plans (Ulips), which combine investment and insurance, are showcased as three-in-one products that allow you to save tax, earn good returns, and get insured. However, many Ulips have a high-cost structure that makes them inefficient. Many investors, who already own adequate insurance, will unnecessarily pay a mortality charge in these instruments. And unlike a term plan, where the mortality charge is fixed for the entire tenure, here it increases with age. Ulips also come with a lock-in of five years. It is, in fact, smarter to keep insurance and investment separate—buy a term plan, which is cost-effective, to meet your insurance needs and use mutual funds, including ELSS, for your investment needs.
ELSS: ELSS offers an excellent combination of a shorter lock-in, market-linked returns, and greater flexibility, thus making it an ideal choice. Investment in any tax-saving instrument under Section 80C—FD, EPF, PPF or NSC—will qualify for the same income-tax deductions. But ELSS holds an edge over the others, as we shall examine next.
ELSS scores one
Shortest lock-in: ELSS has the shortest lock-in compared to other Section 80C investment tools – just three years. Therefore, it allows you greater flexibility over the medium term. However, since it is an equity-linked instrument, you must give it at least seven years to earn good returns, and not withdraw from it as soon as the lock-in ends.
Potentially higher returns: Most Section 80C investment tools offer single-digit returns on an average (between 6-8 per cent). As ELSS invests in equities, it has the potential to offer significantly higher returns—10-12 per cent on an average in the long run.
Better tax treatment on maturity: Barring PPF and National Pension System (NPS), ELSS offers better tax treatment at the time of maturity compared to any other Section 80C investment tools. Long-term capital gains of up to Rs 1 lakh per year from ELSS are exempted from income tax, while long-term capital gains of above Rs 1 lakh are taxed at 10 per cent. Many of the fixed-income instruments under Section 80C are taxed at the investor’s income-tax slab rate. Hence, despite paying a tax, given the market-linked returns, you stand to accumulate a larger sum compared to most of the other fixed-income options.
Selecting the right ELSS:
Instead of going with the best performer over the past three- or five-year horizon, look for a fund that has been a consistent performer. If you compare the calendar yearwise return of a fund over the past five to seven years against its benchmark or category average, you will be able to identify a fund that has been a consistent performer. Many web sites also offer information on the quartile in which a fund’s performance has been in the past, and that too can help you identify a consistent performer.
The writer is chief business officer, Scripbox