Income taxes can seem tricky and we understand why. But tax saving shouldn’t be. We already gave you the lowdown on how to file your tax returns, so now, here is a quick guide to tax saving.
In the speech for the 2020 Union Budget, the finance minister had announced the choice of a new tax regime. As a taxpayer, you can either forgo exemptions and deductions (read discounts) and choose a lower tax rate, or claim exemptions and tax deductions but be subject to a higher tax rate. This may sound simple but it isn’t. The consensus is that if you are already investing in tax-saving instruments or have a home loan, you would benefit from the old regime.
The numerous provisions in the Income Tax act, 1961, ultimately lessen your yearly tax burden. While there are a number of ways to invest and save taxes, here are the seven most popular ones that suit millennial lifestyles:
Most tax deductions are claimed under section 80C. You will see this in the investment declaration sheet your employer provides. Each year, you can claim the life insurance premium that you pay for tax deductions. Let’s say you pay your premiums half yearly, Rs 10,000 every six months, you can claim Rs 20,000 in tax deduction.
Both endowment policies and term insurance policies are applicable for deductions.
ELSS (or tax-saving mutual funds)
This instrument — Equity Linked Savings Scheme — is quite popular among young investors. It allows you to benefit from both equity returns while saving taxes. Market returns for equity funds are historically higher than fixed rate investments, and more so if you stay invested for the long term.
ELSS deductions are also part of the Section 80C. However, each Systematic Investment Plan (periodic) or lumpsum (one time) investment you make is locked in for 3 years. So if you invest Rs 5,000 on August 1, 2020, you will be able to redeem that amount only after August 1, 2023.
To know: If your capital gains (returns generated) exceed Rs 1 lakh in the year, you will have to pay taxes on it.
Unit Linked Insurance Plans
Unit linked insurance plans are a mix of investments and insurance (life cover). You can also claim tax deduction on both the insurance premium and the investment amount. The investment amount can be claimed entirely, while 10% of the insurance part of the premium is tax deductible. This plan also falls under Section 80C.
Fixed deposits or term deposits with a maturity period of five years are eligible for tax exemptions under Section 80C. If you do not want to take the risk of investing in equity markets, this traditional investment plan can do the trick. The interest rates are fixed by banks and are guaranteed. Pro tip: Smaller banks or financial institutions provide a higher rate of interest. The entire amount is tax deductible, though not for the five-year duration, but for the year you invested that amount.
To know: If you withdraw the money before its due date, the tax benefits you have claimed will be nullified. The interest you earn from this (let’s say Rs 5,000) would go into the income from other sources category when filing returns, and may attract additional taxes.
Public Provident Fund
Public provident fund is backed by the Government of India, which fixes the interest rates quarterly. However, the amount you put in each year is locked in for 15 years. Partial withdrawals are allowed after 5 or 7 years (depending on the bank with which you have an account). Often investors look at it as a retirement piggy bank. But if liquidity is a concern, you can try other investment options.
You can invest a maximum of Rs 1.5 lakh in your PPF account each financial year. This is another Section 80C deductible, and the entire amount invested is exempt from taxes. Interest income is not subject to further taxes either, unlike FDs and ELSS.
While your employer may provide you with a health insurance, it is a good idea to add to the coverage. The health insurance that you buy for your family, and parents is exempt from tax under Section 80D. Premiums up to Rs 25,000 for yourself and spouse (plus children) is deductible. If your parents are below 60 years of age, then health insurance premium paid up to Rs 25,000 is deductible. The amount increases to Rs 50,000 if parents are above the age of 60.
To know: You can claim tax deduction on preventive health check-ups too. But as long as they are in the upper limit of health insurance premiums paid that year. If your premium for yourself and the family is Rs 22,000 then a health check-up deduction will be Rs 3,000.
National Pension System
This may sound boring and for older people, but it is hardly that. The returns you generate will be available at retirement, yes, but you can pick investment options. First, you select a fund manager from a list of eight. You then pick between two choices for reinvestment of your money by the manager: Active and Auto Choice. With the active choice, you proportion your investments in different asset classes. The Auto Choice does it for you, based on your risk profile (read age). The asset classes are: E – Equities, C- Corporate debt and G – Government securities, and A- Alternative investment. In an active choice, you can distribute your money as you like, or as advised by your financial advisor.
You can withdraw the invested amount after you retire. You will have to use 40% of the amount to buy annuity (a monthly pension payout). The other 60% is your retirement corpus.
The invested amount under NPS can be claimed under Section 80C for up to Rs 1.5 lakh. Under Section 80CCD (1) an additional Rs 50,000 can be claimed. You can get your employer to deposit up to 10% of your salary in NPS. For self-employed individuals the Rs 50,000 falls under Section 80CCD (1B).
To know: The above is a Tier 1 account, you can further create a Tier 2 account from which withdrawals are allowed at any time.
Important tax-saving FYIs
While you may invest in many or all of these platforms, you can only claim a total deduction of Rs 1.5 lakh under Section 80C each year. Let’s say, if your ELSS and PPF investment together make up Rs 1.5 lakh, you might want to look at health insurance or NPS to save additional taxes.
There are also other ‘hacks’ you can use to reduce taxes:
1. Generally the provident fund (PF) component that employers provide is Rs 1,800 per month. If you are a lazy investor, you could ask your employer to increase the PF component under Voluntary Provident Fund which comes under the Section 80C.
2. Your salary slip will have a House Rent Allowance component. If you stay in a metro city (i.e Delhi, Mumbai, Chennai and Kolkata) your HRA component can increase to 50% of the basic salary. A fun thing to know: You can pay rent to your parents and claim deductions. One of your parents might then have to pay taxes if this is an extra income.
3. More good news coming your way if you are a first-time home buyer. If you took a loan to buy your dream home, you could claim tax deductions on the interest paid and the principal amount. The upper limits are Rs 2 lakh (under Section 24) and Rs 1.5 lakh (but under Section 80C) each year respectively.