Monday, October 27, 2008

Saving Income Tax through Investments

Every Indian who earns an income in India is entitled to pay tax on his income. As per the Indian tax laws we the tax payer is allowed to save his income tax by using the provisions under Sec 80C of the tax laws. To know more about the Indian Income tax laws and the options using which we can reduce our tax pls refer to this link. Income Tax

In this article we will be checking out some investment options that would help us save some cash for our future.

Why do we need to invest?


This is one big question that most of us have but we do not know the best answer. The most common answer is "To Save Income Tax".

Yeah that too is an answer but that is not the first of the reasons. There are a few other compelling reasons why we should invest.

1. Inflation - The Inflation rate of our country is currently at 11%. This means that anything you buy this year for Rs. 100 would be worth Rs. 111 next year. Next year our income would rise but so would our commitments. So if our money is not growing at least at the rate at which the inflation is going, then effectively the worth of our money is going down.
2. Future Income - Today we are in a good job and earning a decent income. After 20 or 30 years we would have to retire some time. After that we would not want to compromise on the life style we are used to. Nor would we want to be dependent on our children to support us. So what is the only option? We must save up some cash that we can use after our retirement. This is possible only by investment.
3. Financial Security - Financial security is something all of us would want to have. If anyone asks us what would make us feel financially secure what would we say? A bank balance of 10 lacs? Yeah that sounds nice. But how would we get such lump sum amounts? The answer is simple. If we start investing now, once our income earning days are over we would be able to sit on a pool of cash that would make us feel financially secure...
4. Saving Income Tax

I have intentionally placed Saving Income tax as the last option because, we must not invest just for the sake of saving tax. We must invest sincerely because we are the ones who is going to enjoy the fruits in future.

In my article on Income tax i have mentioned about 9 options that are available for us under Sec 80C to save tax. Out of these I am going to consider the investment options available. We would not be considering Life Insurance and Home loans because they are not investments but a protection and an asset for us. We will be looking at them one after the other in the increasing order of risk and also the increasing order of Returns.

Remember - "The Greater the Risk, Greater are the Returns" This doesn't mean that we must only in high risk instruments. Definitely not. We must have exposure to safe avenues of investment too because after all it is our hard earned money and we do not want it to go waste. We must maintain a good balance between risky investments and safe investments so that our principal is intact and at the same time our money must grow and beat at least the Inflation rate.


1. Provident Fund

All of us know what Provident Fund is. This is a portion of our salary that our employer deducts every month. This money is remitted to the government of India's PF trust. This money is used by our government for its cash needs. Once we retire or close our PF account, the money that has accumulated against our name would be given back to us. The money in our PF account grows at the rate of 8.5% per annum compounded every year.

Safety = Very high because backed by the government
Returns on Investment = Average - Our Inflation is 11% and the returns on PF is only 8.5%

Investment Strong points:
a. Extremely Safe
b. A small amount every month can help us make up a good corpus over the long run.

Downside:
a. Only average returns.

Note: Ever wondered why the government of India has made PF mandatory for all employers? Even the government wants us to save some money for our future. The best way is to make it mandatory at the source which gives us the income. We should be thankful to our government for doing at least some good things for us :-)

2. Public Provident Fund

PPF is similar to PF with the only difference being, anyone can open a PPF account by visiting the nearest State Bank of India branch. PPF is also managed by the government of India. Once we open a PPF account we can deposit cash in our PPF account anytime. There is one restriction here. We must deposit at least Rs. 500/- every year to keep our PPF account active. The maximum amount we can remit in our PPF account every year is Rs. 70,000/- Our PPF account remains active for 15 years and if we want we can extend it by a further 5 years. We cannot encash the entire amount in our account before the tenure of 15 years. Of course we can do partial withdrawals from our account but we cannot take out the entire corpus.

Safety = Very high because backed by the government
Returns on Investment = Average - Our Inflation is 11% and the returns on PPF is only 8%

Investment Strong points:
a. Extremely Safe
b. A decent amount deposited every year can help us make up a good corpus over the long run.

Downside:
a. Only average returns.
b. Very long lock in period. We cannot take out our cash before 15 years
c. We need to deposit at least Rs. 500/- every year to keep the account active.

3. National Savings Certificate

NSC certificates are certificates of deposits issued by the government of India. Any Indian can deposit cash in NSC. This money would be used by the government for its cash needs. NSC gives us a return of 8% per annum compounded every half year and we can get our amount inclusive of the interest at the end of 6 years. 6 years is the lock in period on NSC certificates. Since these certificates are issued by our government they are extremely safe.

Safety = Very high because backed by the government
Returns on Investment = Average - Our Inflation is 11% and the returns on NSC is only 8%

Investment Strong points:
a. Extremely Safe
b. A decent amount deposited every year can help us make up a good corpus over the long run.

Downside:
a. Only average returns.
b. Long lock in period. We cannot take out our cash before 6 years
c. The Interest earned on NSC is taxable

4. Bank 5 year Fixed Deposits

The latest addition to the tax saving investment options is the Bank 5 year fixed deposit. We can deposit our cash in this special scheme of fixed deposits in any bank. Most banks give us returns as high as 10% for these deposits. The money we deposit is locked in with the bank for 5 years after which we can take back our money. We can opt for periodic interest payments or we can get the interest along with the principal at the end of 5 years.

Safety = High because backed by the RBI
Returns on Investment = Average - Our Inflation is 11% and the returns on FD's is only 9% or 10% max

Investment Strong points:
a. Very Safe
b. A decent amount deposited every year can help us make up a good corpus over the long run.

Downside:
a. Only average returns.
b. Long lock in period. We cannot take out our cash before 5 years
c. The Interest earned on Bank FD's is taxable if it is more than Rs. 10,000/- per annum.


5. Equity Linked Savings Scheme (ELSS)

ELSS mutual funds are a category of Mutual funds that are exempt from Income tax. To know more about Mutual funds Click Here

ELSS mutual funds are special funds that invest predominantly in Large cap stocks (Companies that are very large with exceedingly high capability of profit making, that have been successful for a number of years) ELSS funds have a lock in period of 3 years after which we can take our money if we want. Since the money we invest is invested in the Share market, the returns are not constant. In years in which our market performs well we can expect exceptional returns but at the same time it carries a risk. If our markets perform poorly we may incur losses. But over the years, the Indian share market has been able to give a returns of at least 15-20% year on year.

Safety = Low, because the money is linked to the share market.
Returns on Investment = Very high - If the share market goes up, our returns may exceed 20%. In the past 2 years until Jan 2008, our markets have dished out returns as high as 50%

Invest Strong Points:
a. High returns
b. A small amount investment every month can help us accumulate wealth over the years.
c. Short lock in period. ELSS is the only investment option that has a lock in period of only 3 years.
d. Returns on ELSS are tax free. Both Dividends and the maturity amount.

Downside:
a. High risk because it is linked to the stock market

The most important point:

This is the most important point of this article. "Starting Early"

Starting Early means, starting investing at a young age. Assuming two friends A & B start investing. A is 25 years old and invests Rs. 50,000/- every year for the next 20 years. B is 35 years old and invests Rs. 1 lac every year for the next 20 years. Who do you think will have more cash by the time they are 60 years old?

If you said B then you are wrong. A would have more money because he started early. His investments were able to earn an income on themselves for 35 years which was 10 years more than B's investments.

Assuming you can invest Rs. 1 lac every year for the next 25 years in an instrument that gives you a returns of 10% per annum. By delaying your investment by one year your corpus would fall short by Rs. 3.5 lacs at the end of 25 years. That is the power of compounding. The interest you earn this year would earn interest for you next year. So Start Early :)

Happy Investing...

9 comments:

  1. Good Article....Informative

    ReplyDelete
  2. hi very good artical helped me alot thanks

    ReplyDelete
  3. Thank you Anand, your site is very helpful for begginers like me..

    -Mansi

    ReplyDelete
  4. My salary increased recently and I till now didnt know how to invest to save tax..I just started to learn it..I found your website by chance through Google yesterday...ur articles are helping me a lot to understand how to save income tax and how to save for the future....Thank you so much Anand....God bless u for sharing your knowledge with everyone...

    -Mansi

    ReplyDelete
  5. Thanks for this article. This is very useful for because i m a beginner...

    ReplyDelete
  6. Good article...

    "That is the power of compounding." - true, remember Oseola McCarty !!!

    ReplyDelete
  7. I have just started my career and knew nothing about tax saving until now. Superb article for the novice.

    ReplyDelete
  8. This is such an informative article. I'm just 22 and looking for some good tax saving investments. Thank you Anand.

    ReplyDelete

© 2013 by www.anandvijayakumar.blogspot.com. All rights reserved. No part of this blog or its contents may be reproduced or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without prior written permission of the Author.

Google+ Badge

Google+ Followers

Followers

Popular Posts

Important Disclaimer

All the contents of this blog are the Authors personal opinion only and are not endorsed by any Company. This website or Author does not provide stock recommendations. The purpose of this blog is to educate people about the financial industry and to share my opinion about the day to day happenings in the Indian and world economy. Contents described here are not a recommendation to buy or sell any stock or investment product. The Author does not have any vested interest in recommending or reviewing any Investment Product discussed in this Blog. Readers are requested to perform their own analysis and make investment decisions at their own personal judgement and the site or the author cannot be claimed liable for any losses incurred out of the same.