When the pandemic first reached India in 2020 and the countrywide lockdown was announced in March, the CBDT had extended the 31 March deadline for tax-saving investment till 31 July. The arrival of the Omicron variant has once again set the alarm bells ringing, but taxpayers should not expect any leniency in the deadline this year. As they rush to complete their tax planning for the year, we have put together all the information they need. Like in the past, we have assessed 10 tax-saving instruments on eight key parameters— returns, safety, flexibility, liquidity, costs, transparency, ease of investment and taxability of income. Each parameter is given equal weightage and the composite scores of the various tax-saving options determine their place in the ranking.
The ranking is largely unchanged for the past 2-3 years. ELSS funds are still at No. 1 position, followed closely by the NPS and small saving schemes. Though the tax net has ensnared many investment options, the tax-free Ulips continue to score low due to their inflexibility. And traditional life insurance policies remain the worst way to save tax. They give very low returns and the high premiums prevent the policyholder from investing in other options. That’s why life insurance is at the bottom of the heap this year as well.
We hope you find the ranking useful and are able to choose the best tax saving option.
- ELSS funds
Our rating: 5 stars
Returns: 16.5%
For past five years: These equity funds have given high returns and have the shortest lock-in among all tax savers. But investing a large amount at one go can be risky.
Equity markets are looking precarious and many analysts believe a correction is round the corner. Also, long-term capital gains beyond Rs 1 lakh from equity funds are now taxable. Yet, ELSS funds have topped the list of best tax savers this year as well. That’s because these score handsomely on other parameters. These have the potential to give high returns, there is transparency about where these invest and the costs are very low. Besides, the lock-in period is very short and investors have the flexibility to stop if they want to.
While these are the positive aspects, ELSS funds can be risky due to the volatility in the stock markets. Volatility suits long-term investors who take the SIP route. But the SIP window has closed for taxpayers who have to show proof of Sec 80C tax-saving investments in a few days. So, our advice is not to put a large sum into ELSS funds at one go but stagger the purchases over 2-3 tranches before the 31 March deadline.
Investing in ELSS is very easy if you are already KYC compliant. It can be done online in a matter of minutes directly through a fund house or an investing portal. Keep in mind that some ELSS funds allocate more to small- and mid-cap stocks, while others stick with stable large-cap stocks. Choose a fund that suits your risk profile.
Best performing ELSS funds
- NPS
Our rating: 5 stars
Returns: 8-11%
For past five years: Has a very long lock in period, but additional deduction it offers is very beneficial for high income earners.
The NPS has become more investor friendly over the past few years. The entire 60% of the corpus withdrawn at the time of retirement is tax free. Younger investors can now allocate up to 75% to equities. Older investors can remain invested in the scheme even after they retire till the age of 70 and stagger their withdrawals (see page 9). What’s more, active investors may soon be allowed to change their allocation and pension fund manager up to four times in a year.
At the same time, investors should not expect very high returns from NPS in the short to medium term. Bond yields are beginning to rise and could shoot up if there is a rate hike. In such a situation, NPS investments may not deliver very attractive returns.
But the tax benefits of NPS are unparalleled. The scheme can help save tax under three different sections. Firstly, contributions of up to Rs 1.5 lakh can be claimed as a deduction under the overall Sec 80C. Secondly, there is an additional deduction of up to Rs 50,000 under Sec 80CCD(1b). Thirdly, if the employer puts up to 10% of the basic salary of the individual in the NPS, that amount will not be taxable.
How NPS funds performed
- Ulips
Our ratings: 4 stars
Returns: 9-14.5%
For past five years: The tax on long-term gains from equity funds has made this tax free haven attractive. You don’t pay tax but are stuck with same fund.
Ulips have a distinct tax advantage over ELSS funds. They are also more flexible because investors can switch from equity to debt (or vice versa) depending on their reading of the market. In fact, this feature of Ulips must have been used extensively by policyholders when markets crashed in March 2020. What’s more, there are no tax implications of the gains made from such switching because the income from Ulips is tax free. This makes Ulips an effective rebalancing tool and a one-stop-shop for all financial needs.
But there are some negative points as well. A Ulip may not be able to give you the life cover you actually need. Also, it is a long-term investment and you must continue with the policy for the full term or risk losing liquidity. Ulips also continue to be mis-sold by wealth managers, especially in the last quarter of the year when the 31 March deadline is closing in.
- PPF
Our rating: 4 stars
Interest rate: 7.1% (for Oct-Dec 2021)
For past five years: Tax-free interest makes this more attractive than bank deposits, but watch out for the long lock-in period.
This popular tax-saving option scores high on safety, flexibility and taxability. But the interest rate is low at 7.1%. While bond yields are set to rise, this may not lead to higher rates for small savings schemes. Experts say that the interest offered on small savings schemes is artificially high and should be lower by at least 30-50 basis points. Last year, the government had cut small savings interest rates but had to roll back the decision following a backlash from investors.
The tax-free nature of the PPF makes it better than fixed deposits. It is an investment in which you can’t ever go wrong. An account can be opened in a Post Office branch or designated branches of PSU banks. Some private banks also offer the facility to invest in the PPF. The tenure of the scheme is 15 years from the first investment. On maturity, this can be extended in blocks of five years.
- Senior Citizens’ Saving Scheme
Our ratings: 3 stars
Interest rate: 7.4% (Oct-Dec 2021)
Best way to save tax for senior citizens. Exemption for Rs 50,000 interest makes it more attractive.
The Senior Citizens’ Saving Scheme (SCSS) is the best investment option for those above 60, especially after the additional tax exemption for interest up to Rs 50,000. An account can be opened in a Post Office or at designated branches of banks. It is better to open an account with a bank because operating it will be less cumbersome.
The scheme offers a higher return than the PPF. Banks also offer higher rates to senior citizens for five-year tax-saving fixed deposits, but they cannot match the SCSS. However, the eligibility is restricted to those above 60 years. Also, there is a Rs 15 lakh overall investment limit per individual. These rules have narrowed down the eligibility of the scheme and brought down its overall score in our ranking. In some cases, where the investor has opted for voluntary retirement and has not taken up another job, the minimum age is relaxed to 58 years. There is also no age bar for defence personnel. They can invest in the scheme even before 60 as long as they satisfy the other requirements.
- Sukanya Yojana
Our ratings: 3 stars
Interest rate: 7.6% (Oct-Dec 2021)
This scheme offers higher interest than the PPF, but limited scope has pulled down its ranking.
For taxpayers with a daughter below 10 years, the Sukanya Samriddhi Yojana is a good way to save. At 7.6%, it has the highest interest rate among all small savings schemes. Just like the PPF, the interest earned is tax free and there is an annual cap of Rs 1.5 lakh on the investment. Accounts can be opened in any post office or designated banks with a minimum investment of Rs 1,000. A parent can open an account for a maximum of two daughters, but the combined investment in the two accounts cannot exceed Rs 1.5 lakh in a year. The best part is that the account is opened in the name of the child and the maturity proceeds have to be used for her education and marriage.
Keep in mind that the interest rate is linked to the government bond yield and is subject to change every quarter. However, it has remained unchanged for more than two years despite a consistent fall in bond yields. It seems unlikely that the government will cut rates in this surcharged political environment.
- Pension plans
Our ratings: 3 stars
Returns: 6-9%
Pension plans from insurance companies can’t match the NPS on costs, flexibility and tax benefits.
The government wants to encourage retirement savings, but does not offer the same tax benefits to all instruments. Pension plans from insurance companies are not eligible for the additional tax deduction of Rs 50,000 that is available to NPS under Sec 80CCD(1b). The insurance industry has been lobbying with the Finance Ministry for several years but to no avail. Though this is unfair to the industry, it is unlikely that the coming Budget will curtail the exclusive benefit enjoyed by the government-sponsored NPS.
The NPS also allows the investor to shift from one pension fund manager to another if he is not satisfied with the service or the performance. But in case of a pension plan, the investor is tied to the company till the plan matures. Of course, the taxability of the annuity pension is a problem that both pension plans and the NPS have to contend with.
- NSCs
Our rating: 2 stars
Interest rate: 6.8% (Oct-Dec 2021)
Govt backed option is ultra safe but declining interest rates and taxability have led to low rank.
These used to be one of the most popular tax-saving instruments, but slipped after the interest rates were linked to bond yields. NSCs are now offering very low rates that only marginally higher than what banks are offering on their tax-saving fixed deposits. But the big advantage is that the NSCs comes with sovereign guarantee. The returns are also assured and there’s a short lock-in of five years. Unlike the PPF, the money does not get locked up for several years. Also, you are not required to make a multi-year commitment as in case of insurance plans.
What’s more, the interest earned on the NSC is also eligible for deduction under Section 80C in the following years. Here’s how this works. Suppose an investor buys Rs 50,000 worth of NSCs in January 2022. One year later, the investment would have earned an interest of about Rs 3,400. The investor can claim deduction for this Rs 3,400 for the year 2022-23. The next year, the investment would earn about Rs 3,700 in interest. This can be claimed as a deduction in the year 2023-24.
- Tax-saving FDs
Our ratings: 2 stars
Interest rate: 5.75%-6.3%
Good option for senior citizens who may have exhausted investment limit in SCSS.
The interest rates on tax saving fixed deposits are low, but tax on interest cuts them even further. Since interest is fully taxable, the post tax rate for investors in the 30% tax bracket is less than 5%. That is roughly what endowment insurance policies deliver.
Tax-saving bank fixed deposits suit those who have delayed their tax planning and are now running around searching for the best investment option. If someone has to show proof of investment this week, all he has to do is log on to his Netbanking account. A few clicks of the mouse is all it takes to invest in a tax saving fixed deposit. This is possible 24x7 and from anywhere. Even if his bank has closed for the day or the investor has to go out of town, he can easily open a fixed deposit using Netbanking. Keep in mind that you cannot invest in a fixed deposit in somebody else’s name using your Netbanking account.
- Life insurance policies
Our rating: 1 star
Returns: 5-6%
These continue to be the worst way to save tax. Corpus is tax free but score low on flexibility and returns.
We firmly believe that life insurance is the lynchpin of a financial plan because it protects the goals of the individual even if he is not around. But this purpose is best accomplished through a pure protection term plan. Term plans have no investment component so the entire premium goes towards mortality charges. They also cost a fraction of what you pay for a traditional endowment policy or a money back plan. A 30-year-old man can buy a cover of 1 crore for 30 years by paying an annual premium of Rs 12,000-14,000 per year. In comparison, an endowment plan offering a cover of Rs 40-50 lakh will cost the buyer almost Rs 4-5 lakh per year. The only good thing about life insurance policies is the guaranteed returns and tax-free maturity corpus. But these benefits are far outweighed by the low returns and inflexibility of the instrument.
