Section 80C: Beyond the Lure of the Safety Net

It is that quarter of the year that generally witnesses a surge in the sale of tax saving instruments. However the last minute rush by individuals to subscribe to these instruments often results in the wrong choice of products. This blog throws light on some of the key considerations to be made when making a choice under the famed 80C Tax Saving Category of Financial Products.

For the average tax payer, 80C is the be-all and end-all of Tax planning. As far as Tax Planning is concerned, there is a world beyond 80C too. Nevertheless, in this article, we will restrict our discussion to the various possibilities within the microcosm of 80C instruments.

While Section 80C presents us with innumerable tax saving options to choose from, picking the right one often remains a challenge for most. The inability to choose the right product stems not so much from the lack of easy access to certain financial products, but rather from inadequate awareness about the nature of these products and their impact on our overall finances.

Thus with limited understanding of these products, when faced with making a choice, most investors veer towards traditional tax saving instruments. But many of these traditional instruments suffer from major drawbacks such as sub-optimal returns and high lock-in period. The initial advantage, thus gained, in terms of overall tax savings, is frittered away by locking the investment amount in an inefficient product.

Section 80C and its various sub sections offer tax payers an overall deduction benefit of Rs.1,50,000/-. However there are many instruments that compete in this space for their share of this paltry sum of Rs.1.5 Lakh. Moreover what makes matters worse is that, it is precisely during this time of the year i.e. the Jan-Feb-Mar quarter, many of the Savings, Investment and Insurance products are aggressively marketed with 80C as the core benefit, thus leaving investors with an overload of choices and information. So how does one make sense of this clutter?

To begin with, one must understand that there are several notified expenses, and statutory contributions made by us, that qualify for 80C benefit thereby giving us a fair amount of automatic deduction even before we hunt for suitable tax saving instruments. This means that the actual amount of investment required to be done under 80C for gaining maximum tax benefits would be much lower than the prescribed 80C limit of Rs.1,50,000/- (because of the auto-qualifying deductions).

So, as an individual, when it comes to 80C investments, how do we make sure that we get the amount as well as the instrument right?

Let’s begin with listing down some of the popular heads that qualify for deduction under Section 80C:

1. Children’s Tuition Fees (Max 2 children)

2. Home Loan Principal

3. Life Insurance Premium (Term, Endowment, etc.)

4. Premium Paid for Pension Plans of Life Insurance Companies

5. Employee Provident Fund (EPF) - (Employee Contribution)

6. Voluntary Provident Fund (VPF)

7. Public Provident Fund (PPF)

8. Sukanya Samriddhi Yojana (SSY)

9. 5-Year Tax Saving Bank FDs

10. National Pension System (NPS) - 80CCD-1

11. National Savings Certificate (NSC)

12. Equity Linked Savings Scheme (ELSS)

Of these, some heads such as Children’s Tuition Fees, Life Insurance Premium, Home Loan Principal, etc. are expenses that are driven by an Individual’s/Family’s higher order needs and not necessarily by the need to plan taxes alone. In most such cases, the tax benefit is incidental. Even EPF contributions made by employees with the larger objective of accumulating for retirement, qualify for 80C benefit. Most individuals in our view would be making one or several of these expenses/contributions. Additionally some individuals would have already made a few tax saving investments during the year.

Hence the preliminary step for an individual planning for 80C would be to compute the total of all such expenses/investments that are already in place. This should then be reduced from the overall 80C deduction limit of Rs.1,50,000/-. The balance amount is the actual deficit that needs to be plugged by way of subscribing to appropriate Tax Saving Instruments. Any investment in 80C products beyond this deficit amount will not yield any additional tax benefits.

The next step is determining the most appropriate instrument from amongst the available choices.

Most traditional tax saving (investment) instruments barely manage to beat inflation and come with high average Lock-in period of 5 years. Despite their shortcomings, most of these instruments have for long enjoyed the unstinted confidence of individual tax payers. Partly, this could be attributed to aggressive marketing strategies and to an extent gross miss-selling; and the unsuspecting ones among us fall for it.

Of the various popular tax saving options available under the 80C category shared above, the one product that has failed to catch the fancy of tax payers, despite having proven credentials, is the Equity Linked Savings Scheme. In fact it is arguably the only tax saving instrument, with the potential to comfortably beat inflation in the long run. More so, ELSS instruments enjoy better liquidity as they come with the lowest lock-in period. However as is the case with most equity based instruments, this instrument too comes with its fair share of volatility. The impact of volatility is largely visible in the short run though. Therefore, by investing systematically and staying invested for long we can negotiate volatility and make it work to our advantage.

So let’s highlight a few features of / benefits offered by ELSS:

1. Returns: Since ELSS is an equity based instrument, it has the potential to generate superior returns in the long run. Most traditional instruments give sub-optimal returns that barely beat inflation.

For e.g. Rs.1,50,000/- invested as a lump sum in a Traditional Tax Saving Instrument (for e.g. Bank FD/ Traditional Endowment Policy) at the beginning of every year for 25 years will create a corpus of approximately Rs.87 Lakh (Assumed Returns on Traditional Instruments – 6% p.a. based on historical trends). On the contrary, the same annual amount of Rs.1,50,000/- split over 12 months (Rs.12,500/-p.m.) invested in SIP mode in ELSS over a 25 year time period builds a corpus of a little over Rs.2 Crore… (Assumed Returns on ELSS – 12% p.a. based on historical trends)…

Too big a Difference to Ignore…

2. Diversification: Being an equity fund, ELSS provides you with a piece of a strong diversified portfolio at a reasonable cost.

3. Volatility: Volatility is a given in any Equity based instrument and is no different with ELSS. The only way to manage volatility is adopt systematic investing and staying invested for a considerably long time period. Although traditional instruments offer the assurance of fixed returns, the assurance comes at the expense of returns.

4. Liquidity: While most traditional tax saving instruments come with a five-year Lock-in period, ELSS scores big on this front too as it comes with the lowest lock-in period of 3 years.

5. TDS: There’s no TDS on equity based instruments like ELSS. Tax implication arises only at the time of redemption. Tax Saving Bank FDs however, suffer from this major disadvantage.

6. Taxability of Returns on Maturity / At Redemption: ELSS instruments attract Long Term Capital Gains Tax @ 10% beyond realized gains of Rs.1,00,000/- (cumulative gains realized from all equity based instruments in a year). However this tax can be avoided too by smartly managing our sell transactions. Given the superior returns generating potential of equity based instruments, even when assessed in terms of post-tax returns, ELSS remains far ahead of the other instruments. The gains on instruments like Bank FDs are taxed every year right up to maturity.

You would notice that ELSS comes out tall and strong under most considerations and hence with such instruments you stand a real chance of making your savings grow at a much faster pace compared to traditional tax saving options that camouflage sub-optimal returns in the garb of Safety & Security.

Conventional wisdom may tell us to limit our expectations and settle for safe and modest returns. Nevertheless, this perceived safety net clouds our thinking and makes us err in our choice. There is a clear need to break the “Safe is Always Better” mindset and explore the immense growth promise offered by equity, while at the same time saving some taxes.

So look beyond the traps of Assurances and Guarantees… Make Prudent Financial Choices…

Embrace ELSS… Embrace the Triple Advantage of Tax Savings, Higher Growth and Better Liquidity…

Note: Many of my readers ask me whether one must invest in instruments like PPF for tax savings. Personally, I believe instruments like PPF are very effective tools and can serve us good not just from a tax saving perspective but also from an overall utility point of view, if used the right way. However young tax payers, whether from a tax planning viewpoint or otherwise, should make sure that they leverage equity to the extent possible in their early years. Fixed Income Instruments will find higher utility value mostly in the later years of our life… For now, we reserve this topic for a detailed discussion under an appropriate head…

Till then… Stay Connected…

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