Since the deadline for filing income tax (ITR) returns for fiscal year 2019-20 (tax year 2020-21) is December 31, we need to look at debt and equity investments to calculate the tax. Since investments must be made every year to save tax, we need to spread the long-term investment for composite benefits. Long-term investing can help build a significant corpus and help an investor understand market cycles.
Since taxes lower total returns, investors should diversify their portfolio into stocks, debt and real estate and consider the tax implications before investing.
Taxation of debt investments
Fixed deposits: Investors prefer fixed deposits for guaranteed returns, high liquidity and ease of investment. While deposits of 5 years and above, either at a bank or at the post office, are tax deductible under Section 80C, interest earned over all maturities is taxed at the marginal tax rate. However, seniors get an exemption of up to Rs 50,000 on interest earned on deposits.
Debt-oriented mutual funds: Individuals invest in debt-oriented mutual funds and fund houses invest the money in fixed income securities that are issued, such as government paper, treasury bills, money market instruments and corporate bonds. However, these investments involve interest and credit risks. Short-term capital gains (STCG) for an investment period of less than three years are taxed at the individual slab rate. Long-term capital gains (LTCG) are taxed at 20% plus surcharge and stop indexation.
Public Provident Fund: It is the most popular tax-saving tool and the interest is tied to bond yields. Currently, PPF provides an annual compounded return of 7.1% per year. Rates can change quarterly depending on bond yields. Investors are entitled to a tax deduction under Section 80C on the investment paid, interest paid is tax free and the proceeds from the term are also tax free.
National savings certificates: The five-year national savings certificate is a popular investment option for risk-averse investors, currently offering a 6.8% interest rate compounded annually but payable on maturity. The deposits qualify for tax relief under Section 80. And since the interest earned on the NSC each year is not paid out and reinvested, the amount of interest also qualifies for tax relief under Section 80C. Since the interest from the last year (at maturity) cannot be reinvested, an investor will have to pay tax at his marginal rate on the interest earned for that one year. Unlike banks, post offices do not deduct withholding tax and the interest income will have to be reported in the income tax returns and the tax paid on them.
Tax on equity investments
Equity-linked savings plan (ELSS): It is a good option for not only saving tax, but also achieving higher returns in the long run. There is a three-year lock-in and almost the entire amount is invested in shares of various companies. It has the lowest lock-in period compared to other tax-saving instruments such as PPF, NSC and 5-year fixed bank deposits. There is no limit or limit on how much a person can invest in an ELSS. An investor will get tax deductions of up to Rs 1.5 lakh for investments in ELSS under section 80C. If a taxpayer in the highest bracket of 30% invests up to Rs 1.5 lakh in ELSS within a year, he can save Rs 46,350 in taxes. Investors will have to pay LTCG tax at 10% plus surcharge and cess after one year. The tax applies to the redemption of profits in excess of Rs 1 lakh in a year.
Unit-linked insurance plan: These are market-related investment products with a thin crust of life insurance and the lock-in period is five years. Policyholders have the option to select large, mid or small cap or even debt funds to invest, depending on their risk appetite. The amount invested in Ulips is eligible for tax deduction under Section 80C up to a maximum of Rs 1.5 lakh per annum, but with the condition that the premium payable cannot exceed 10% of the capital insured. As the maturity proceeds are exempt for life insurance, Ulips is tax exempt at maturity and is an exempt exempt product.
Equity mutual funds: Unlike ELSS, equity-related mutual funds do not receive a tax deduction under Section 80C. LTCG over Rs 1 lakh and holding period over one year is taxed at 10% plus surcharge and cess. STCG is taxed at 15% plus surcharge and cess. Dividends are taxed at slab rates.
Taxation of hybrid instruments
National pension scheme: It is an ideal investment tool for retirement planning. Although it is market-based, it is less volatile in the long run than mutual funds due to the asset mix of equity, government and corporate debt. Investors will get tax deductions of up to Rs 50,000 in a year under Section 80CCD, which is higher than the benefit available at Rs 1.5 lakh under Section 80C. At maturity, 40% of the corpus is invested in annuities and the remainder is paid out to the investor tax-free.