Paying taxes is painful. Nobody wants to part with a significant part of their income every month. But we can’t avoid taxes. At best, we can minimize them smartly & legally.
But then, there are so many tax-saving options to choose from. It’s a big maze out there. Unfortunately, you need to have a broad understanding of all of them to see which suits you best.
Broadly tax-saving options can be classified under three buckets - Expenses, Loan Repayments and Investments.
A step-by-step comprehensive guide follows:
Expenses
There are some expenses that you just cannot avoid. Fortunately, the government has made some of these expenses tax deductible. So the money spent on these expenses is deducted from your taxable income.
HRA
HRA or House Rent Allowance is a part of your salary (check your salary slip and you will know). You can claim deduction of HRA amount from taxable income if you are staying on rent.
But entire HRA amount may not be exempt. The exempted HRA amount is calculated as follows:
Lowest of the following three:
- HRA received from the employer
- Actual Rent - 10% of Basic Salary
- 40% of Basic Salary. (If you reside in a metro city, then 50% of Basic Salary)
HRA exemption is covered under Section 10 of the Income Tax Act.
Life Insurance Premiums
The premiums you pay for any life insurance policy (term plan, endowment plan, ULIP) can be deduced from your income for purpose of taxation
You can claim deduction on premiums paid for yourself, spouse or your children. The limit to amount that can be claimed for deduction is set by Section 80C* (which has an overall limit of Rs 1.5 lac).
Section 80C has an overall limit of Rs 1.5 lac (for all products combined). Hence all mentions of this section in rest of the article should be considered with this limit in mind
Health Insurance Premiums + Health Checkup
Like life insurance, having a health insurance is a must for everyone.
The health insurance premium paid for self, spouse or dependent children is tax deductible upto Rs 25,000 under Section 80D.
If you are paying health insurance premium for your parents, then you can get additional deduction of Rs 25,000 or Rs 30,000 depending on whether your parents are below or above 60 respectively.
Even preventive health checkups (of upto Rs5000) can be claimed as tax deductions under the same section (but within above specified limits)
Education (Tuition) Fees for Children
If you have kids who are studying, then you can get some tax benefits on their fees.
The amount you pay as tuition fees for upto 2 children is covered under section 80C (with limit of Rs 1.5 lac).
Loan Repayments
Again, loan repayment is something that cannot be avoided. Alas! But you are allowed to claim some amount you repay is deductible from your taxable income. So that lessens the burden of loans somewhat
Home Loan Repayment
If you have a home loan, then you can get tax benefits for paying your loan EMIs. You loan EMI has two components:
- Principal repayment
- Interest payment
You can get benefits on both under different sections.
Section 80C allows you to claim the principal component of the EMI as deduction.
Section 24 allows you to claim the interest paid on Home Loan as deduction. If the property is self-occupied, then the limit is Rs 2 lacs. If the property is not self-occupied, then there is no limit.
Education Loan Repayment
If you have taken an education loan for yourself, spouse or children, the interest component of loan is tax deductible under section 80E.
Principal repayment of education loan doesn’t qualify for any tax benefits.
Investments
Here is the big one. Previous two sections were about expenses (general and loan related) that can give you tax benefits.
But there are investment options that give you tax benefits too. So what is essentially happening here is that you are investing money for future and getting tax benefits today itself. It’s a win-win for you.
Employee Provident Fund (EPF) and VPF
If you have seen your salary slip, you will know that every month, your employer deducts a part of your salary towards EPF. This amount is eligible for deduction under Section 80C.
Returns: 8-9%
Tax on Returns: Nil*
Lock-in Period: Till retirement*
Public Provident Fund (PPF)
PPF is similar to EPF but not linked to employer. You alone can make contributions to this PF. Like EPF, this is considered one of the safer options to invest your money. PPF rates are now open to revision every quarter.
Returns: 8%
Tax on Returns: Nil
Lock-in Period: 15 years (extendable by 5 years at a time)
Equity Linked Savings Scheme (ELSS)
ELSS is equity mutual fund scheme that allows you to invest in equities to achieve higher returns.
Unlike other mutual funds, ELSS also gives tax benefits. The amount you invest in these are eligible for deduction under Section 80C.
ELSS has historically beaten all other tax-saving instruments over the long term. Also, the lock-in period is the least among all tax-saving options.
Returns: 15-20% (Market returns, Long term historical average)
Tax on Returns: Nil
Lock-in Period: 3 years
Tax-Free Infrastructure Bonds
Some Indian infrastructure companies are allowed to issue infrastructure bonds. Investment in some of these bonds is eligible for tax benefits under Section 80CCF. Currently, a maximum deduction of Rs 20,000 (per year) can be claimed for investing in these bonds.
The deduction under Section 80CCF is over and above the deduction available under Section 80C.
Returns: Depend on bond being invested (generally less than 9%)
Tax on Returns: Interest is taxable
Lock-in Period: Upto 10 years
5-year Bank FDs
Bank FDs need no introduction. 5-year FDs are tax-saving variants of regular FDs. The amount invested in 5-year FD is eligible of deduction under Section 80C.
Returns: 6-7% post tax (depending on tax-slab)
Tax on Returns: Interest is taxable and to be paid yearly
Lock-in Period: 5 years
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Already tired of reading this list of tax saving options?
We can understand your plight. There are indeed an unnecessarily large number of available options.
Apart from ones discussed above, there is National Pension Scheme, Rajiv Gandhi Equity Scheme for investments in Equities (RGESS), Sukanya Samriddhi Scheme, NSC, deduction for medical expenses of dependents, offsetting short term capital losses against short or long term capital gains, contribution to political parties (!), etc.
Enough! Just tell me How to Save Tax Now!
So cut a very long and ‘taxing’ story short, there are just few things that you as a young investor should do to get the maximum possible tax benefits:
- Ensure you claim your HRA tax benefits
- Ensure you claim your loan (home, education) repayment tax benefits.
- Ensure you claim your term insurance premium related tax benefit
- Ensure you claim your health insurance premium related tax benefit
- If you have EPF, then invest remaining amount in ELSS
- If you don't have EPF, divide investible money between ELSS and PPF (ELSS gives better long term returns than PPF)
Also, not all products that give you tax benefits now will give you good post-tax returns in future.
Case in point is PPF. Both PPF and ELSS contributions (upto Rs 1.5 lac) are eligible for deduction under Section 80C. But when it comes to post tax returns, ELSS is far ahead with average returns given by good funds at 15-20%, whereas PPF lags behind with around 8.0% returns.
So even when you are evaluating a financial product for tax-saving, always look at post-tax returns offered by it and compare it with other alternatives.
