ABC of section 80C

November 23, 2011 For people Section 80C has become synonym to tax saving. Everyone jumps on one of the products which are available there for investment. In India tax saving & investment go hand in hand some time it shocks me, when I hear people saying that their investment is only what they are doing for tax savings. Let me clarify in the starting of the article that if you are one of those who think that investing only for tax saving will be enough for you to achieve all your goals or a single goal like retirement you are terribly wrong. And sooner you realize it is better as time cannot be substituted, in most of the financial products.

Always remember your tax saving should be result of your investment planning & not vice versa. This means first we make our goals, make a plan for it, then choose an investment strategy and after that we see that can any tax saving instrument can become part of overall strategy or not. What is Section 80C Section 80C provides you deduction upto Rs 1 lakh from once income. It is applicable for any individual or HUF and also for any income level. As this is a deduction this actually reduces your gross income for tax purpose. So if you have earned Rs 5 lakh in this year & you used 1 lakh limit of section 80 C you have to calculate tax only on Rs 4 lakh. Lets understand it with example: Mohan & his friend Sohan who joined IT company this year at same level & are going to earn Rs 10 Lakh. Mohan was enjoying his life at fullest & never thought that he has to invest any amount to save tax. So he actually planned to pay tax or we can say he was not having any choice but to pay tax. Sohan was a good saver & had some idea about tax

saving he kept aside some portion of his salary to invest in some tax saving instrument. Last week one of the insurance agents meets Sohan & told him about how he can save tax under section 80C by investing in their newly launched endowment policy. So Sohan invested Rs 1 Lakh in their policy & saved tax. Lets see how their finance looks: Particulars Mohan Salary 1000000 Interest Income 0 Taxable Income 1000000 Deduction U/S 80C 0 Net Taxable Income 1000000 Income Tax Liability 0-180000 @0% 0 180001-500000 @10% 32000 500001-800000 @20% 60000 800001 Above @30% 60000 Total Income Tax 152000 Education Cess @3% 4560 Total Income Tax Payable 156560 Sohan 1000000 0 1000000 100000 900000 0 32000 60000 30000 122000 3720 125660

You must be thinking that how smart is Sohan he saved a tax of Rs 30900. But I think he was equally dumb because he forgot the basic principal your tax saving should be result of your investment planning & not vice versa. Two Mistakes that Sohan did: 1. Invested in Low yielding expensive insurance policy. 2. Not considered his EPF contribution. This is deducted form you monthly salary @ 12% of your basic. Your employer also contributes the same amount. Your contribution qualifies the Sec 80C investment. Various options available under section 80C & which one is suitable for you. Instruments that dont even need investment 1. Childrens Tuition Fees. This deduction is available for 2 children with total limit of Rs 100000. So for this the fee receipt that you get from school is the document that you need to furnish. 2. Home Loan Principal Payment: If you have taken a Housing loan and look at the payment schedule, it is bifurcated into two parts. One is you principal payment and second is your interest repayment. You can also contact the bank or the loan

company for a certificate, which will describe your principal and interest payment outgo. Instruments that need Investments. We can further divide into 2 parts

Debt Oriented: The instruments under this category are EPF, PPF, NSC, Bank term Deposit, Senior Citizen Savings Scheme and Post office Time deposit above 5 years. For complete details check table. Other than these there are Insurance policies which also come under these categories but we have not included them in table as our suggestion is dont mix insurance with investment. There return varies from 4.5 to 6%.

Equity Oriented

i. ULIP: Unit Linked Insurance Plans are the insurance plans where a portion of your premium goes as an investment, similar to mutual fund. The returns of these plans are market linked. These plans are very complex & also expensive. ii. ELSS: These are Diversified Equity mutual Fund schemes with lockin of 3 years. The returns are also linked to the performance of equity markets. (Read ELSS: best tax saving instrument undoubtedly) You should think about the following criteria, before selecting your tax saving investments:

Liquidity: All these products have different lock-ins. Consider your requirement of funds before you invest. Risk and Return: An ELSS can you give highest return but are volatile. So consider how much risk you can take. Inflation protection: These product yield returns in wide range. So consider a product which at least beat inflation and suite you on risk parameter as well.

We can make this bit easy by suggesting instrument by age:

Young maximum contribution in ELSS & with some portion in PPF. Middle Age Equal Contribution in PPF & ELSS. Retired Senor Citizen Scheme & Fixed Deposit will be better. Still consider some contribution to ELSS if your asset allocation is tilted towards debt. Lets assume that one person who is 30 years now & want to invest in tax saving instruments till his retirement. How much corpus will be build if you invest Rs 30000 every year in Endowment Plan(6%), PPF(8% before change) & ELSS(12%) for 25 years.

Hidden Gem of Section 80C: Term Insurance: Term Insurance is the cheapest policy available and hence hardly talked about by agents and even insurance companies never promote such cheap and low cost product. Term policy is insurance at its purest and simplest form. You pay premiums because there is a guarantee that if something happens to you, your family will be paid out the pre-decided amount, hence you have the peace of mind that even if you are not there, those loved ones you leave behind will not have to bear a financial loss. Term Insurance is protection against risk of life. You must buy it & also avail section 80C benefit on it.