When we did a survey of the biggest destroyer of wealth it came as no surprise that TAX was the ultimate doom and gloom of citizens around the world.
Which is why it’s just as important to prepare for taxes, or what we call tax planning. And there’s a season for it. Keep in mind the following:
- Tax Avoidance is fine.
- Tax Evasion is NOT fine.
Tax avoidance is fine because we can legally avoid paying taxes. I hate the word avoidance, so let’s call it Tax Saving.
As you start to navigate the Indian Tax system, you will hear about Section 80C, 80D, 80E, 24A, 24B and some added combination of these.
Don’t worry. This is just a way to keep the tax accountants employed. They have to look like they’re knowledgeable and worth paying!
There is a way to reduce your (income) tax liability by investing in certain financial instruments or making certain payments.
Typically, most saving schemes will revolve around 80C, because it talks about investing money (and some part about spending money, but we’re more interested in investing so let’s talk about that).
I wanted to know how I could save tax. Honestly, I would rather we make more money, and pay little tax.
Remember, the more time you spend doing this, the bigger waste of your most precious resource. Does investing in these schemes justify your time and effort of researching, and investing and then gaining some deductions? Let's have a look at the options:
|Equity Linked Savings Scheme (ELSS)||3 year||12%-15%*||M/H||LTCG 10% > 1 Lakh|
|Public Provident Fund (PPF)||15 year||7.1%||L||*|
|National Savings Certificate (NSC)||5 year||6.8%||L||*|
|National Pension System (NPS)||5 year||8%-10%||M||*|
|Senior Citizens Saving Scheme (SCSS)||*||6.5%||L||*|
|Sukanya Samriddhi Savings Scheme (SSSS)||*||*||*||*|
|Five Year Fixed Deposits (Bank/PO)||5 year||5.5%||L||*|
Keep in mind that inflation is around 5% (as of 16 March 2021), so you have to be generating more than that to be creating wealth.
Spending for 80C
- Life Insurance Policy comes under 80C, and Medical Insurance comes under 80D. If there’s anything you do, and you must do first - is take a Medical Insurance. It’s a MUST. An estimate entry & exit into a private hospital can cost you somewhere between ₹4-8 lakhs. The earlier you take this, the better. And even more so, if you have dependents on your income generating capability.
- Home Loans - these are at a low of 6.7%, I remember the days when this used to be 14%! More on this later on.
Whenever we enter the month of March, that is the end of one financial year, that's when this gets the most attention. Here’s the time (now in April) to get your tax savings investments in order. We’re all last minute, I get it.
But our focus is on investing what you save, let's move on:
Why you should save taxes with ELSS
ELSS - is like a mutual fund, the fund HAS to invest a minimum of 65% in equity, with a lock in period of 3 years (the shortest of all 80C investment options), and the Long Term Capital Gain taxable at 10% only if the gain is above 1 lakh.
So if you invest ₹1 lakh and it doubles, you will be exempt from paying taxes, but if you invest ₹1.5 lakh and it doubles, you will be required to pay taxes on the excess above ₹1 lakh - in this case, you will pay 10% of the ₹50,000 gain — so plan your exit (redemptions) accordingly.
And the minimum investment is ₹ 500 - which is pretty good. We like to think that it offers a dual benefit of tax savings & wealth creation (the latter depends on when you invest in the ELSS though).
While there is no limit to how much you can invest in an ELSS, you can invest upto ₹1.5 lakh in an ELSS every year, which will save you upto ₹46,800 of taxes (i.e. you get a deduction on your tax payable, this is what they often call “tax benefits of ₹1.5 lakh”).
Which scheme / plan - dividend or growth?
There are dividend options, which I typically prefer, but maybe in this case, it’s better to just buy and forget - so go for the growth plan via an SIP. Also, from a tax efficiency point of view, especially for an ELSS, it doesn’t make sense given that as per the Finance Act 2020, dividend income is now taxable and if the dividend is more than ₹5,000 it will be subject to TDS (7.5%). If you have already selected dividend mode, you can ask your mutual fund to change it to growth.
Investment Horizon (Lock-in Period)
Typically, an investor would like to get his money back after the 3 year lock in period. This is what most mutual fund companies are using as a selling point. But the question is should you?
If you’re an investor, think very long term, or at least a medium-long term of 5-7 years. Market cycles, usually follow a 7 year cycle (bottom to top), so holding for that long, would be best. This is even more important when you’re investing at the top of the market cycle.
And so long as you do not redeem the ELSS, you do not pay taxes. You never know, my overall thesis is that the Indian government will reduce taxes in the future, you will stand to benefit from holding.
Remember if the ELSS mutual fund underperforms, you’re stuck with it for 3 years, i.e. the lock-in period. You’ll have to bear the cost of bad performance for that long before you can make an adjustment, which brings us to the next important point.
Investment Plan (Lump-sum Vs. Systematic Investment Plan)
Another thing to keep in mind is to avoid doing a lump-sum investment, unless you haven’t invested and it is crash like March 2020. Those are once-in-a-lifetime-opportunities. The best way is to start the Systematic Investment Plan (SIP) in April, i.e. the start of the financial year, and continue for 12 months. So if you’re investing ₹1.5 lakh, then set an SIP for ₹12,500 each month (or do weekly if you like). This will take care of the volatility during the year.
Try not to invest in too many ELSS tax saving mutual funds, as it is they’re diversified enough. Adding to that diversification has a reducing marginal benefit. Do two or three. So based on the above SIP allocation, you can do around ₹4,000 per fund (we’ve mentioned a few at the bottom, read on or skip).
With an ELSS, given the tax benefits you gain, to make the most of it, you will have to allocate ₹1.5 lakh each year to an ELSS mutual fund. That means say up to the age of 60, assuming you’re starting at 40 years (30 years), that should be around ₹30 lakh (₹45 lakh) of investments in total, so that you can get that same tax deduction each year of ₹1.5 lakh, effectively saving you ₹9,36,000 (₹46,800 x 20 years) that can be enjoyed by you (and you will still pay tax indirectly when you spend it)!
When markets are at an ALL TIME HIGH (ATH), it’s probably not a good time to invest in ELSS mutual funds. Consider [[National Savings Certificate (NSC)]] at times like this, especially if it’s the last month of the financial year.
Also, don’t leave your investment decision to 31 March. There’s a clear guidance that even if you invest in an ELSS, and money leaves your account. The date of allocation by the Fund House is what will be considered. Even if you consider an NSC, give cash instead of cheque, as the banks will be piled up with cheque clearances towards the end of March.
The best strategy, is to start an SIP in the first week of April for 12 months. Let’s get into that:
So now that we see the ELSS as the best option, with a bit of extra risk, which one should you opt for?
Well, if you do, do it before the 31 March of each year, to get the benefit of it. Through an informal survey via twitter, these are the top 3 to invest in:
|Fund Name||Monthly SIP||Expense Ratio||Crisil Rank||Value Research|
|Mirae Asset Tax Saver Fund (Growth)||₹5,000||0.28*||2||5 / 5|
|Canara Robeco Equity Tax Saver (Growth)||₹5,000||1.02||1||4 / 5|
|Axis Long Term Equity Fund (Growth)||₹5,000||0.72||1||4 / 5|
Mirae & Axis are favourites, not just with investors, but also CRISIL who have given these highest ranks.
Keep in mind these are all "Direct Plans". Over the long-term you actually save a lot with this option, this is basically avoiding paying extra to mutual fund distributors who are milking the cream of your future wealth. Choose Zerodha or Groww or one of these new age FinTech companies.
The above allocation suggested is because of the way SIPs are done, yes, it is slightly higher than your ₹1.5 lakh tax benefit limit by 20%, for two reasons:
- The SIPs may not be exactly be the amount you invest in, they could be +/- based on the NAV and;
- More people will be investing in this pushing prices up higher, especially during the March periods when you can book some profits.
Let’s take a closer look at how the above performed on a 12 month (1 year) basis, as well as 36 month (3 year) basis. This is only to give you an idea, and not an indication that this will continue.
Mirae Asset Tax Saver Fund (Growth)
Canara Robeco Equity Tax Saver (Growth)
Axis Long Term Equity Fund (Growth)
So over 36 Months (3 Years), you could expect anywhere between 22 - 28% returns. We’ve also compared all 3 funds together, and you’ll see how they performed during this period:
Some other notable mentions are:
- Quant Tax Plan (highest mid & small, value oriented) // different from Quant Tax Savings Plan (Quantum MF)
- BOI Axa Tax Advantage Fund (Growth)
- Invesco India Tax Plan
- DSP Tax Saver Fund
- Tata India Tax Savings Fund
- Parag Parikh Tax Saver Fund (PPFAS) - Value Investing (The fund managers have own money invested)
Keep in mind, there is no guarantee of returns in ELSS tax saving mutual funds. As with the typical mutual fund disclaimer (read fast) — past performance of tax saver fund may or may not repeat in the future and are subject to market risks, read the document before investing.
The above information will change from time-to-time, and I may not be able to update it. Some information is missing, or being updated, so we will leave them with *. And remember to read the disclaimer below! Happy Investing... may your longs go up and your shorts go down.