Tax Cuttings, Returns and Saving Money

The investment world is vast and complicated, and most people often fail to see, or choose to overlook the intricacies involved. The decision on where to invest is often arrived at arbitrarily; for example because a relative/friend/ colleague recommended it.

But investing is much more than that. Investing involves not only looking at returns but also understanding impact of other variables like inflation or taxation on returns. In this article, let us look closely at the impact of taxation on returns.

Public Provident Fund (PPF) versus bank fixed deposits FD
On the face of it PPF and FDs may look starkly similar.Both are low-risk options and offer moderate and more or less similar returns. PPF has a 15 Year term; FDs can have varied terms.

Now coming to the tax aspects. As far as deductions are concerned, both are available for deduction under secion 80C. However, an FD with a lock in of 5 years qualifies.

Coming to the returns. Returns on FDs are taxable, but the return on PPF is tax-free. So, lets say, if both these options gave a return of 8 per cent. The post tax returns on PPF would still be 8 per cent but on an FD it would be 5.6 per cent (assuming you are in the 30 per cent tax bracket).

NSCs, KVPs and Govt. of India Bonds
National Savings Certificate (NSC) and Kisan Vikas Patra (KVP) provide a returns of 8 per cent. However, the interest is taxable and if you are in the highest tax bracket of 30 per cent, your post tax returns come to 5.6 per cent.

So other things being equal, you should be looking at investing in options which offer higher post-tax returns or preferably options which give tax-free returns. And as far as possible avoid investments in options where the returns could get taxed substantially. Let us look at some such options.

Equity MFs and stocks
In the long term, equities are relatively less risky and the systematic investing route can definitely help reduce the downside. Also, equity mutual funds or direct equities become tax efficient only in the long term. If you sell your equity mutual fund or share holdings after holding them for over 1 year, you would not be liable to pay any tax. If you sell them before 1 year, your gains would attract a short term capital gain tax of 15 per cent plus cess.

Insurance versus Pension Plan
Pension plans have always been a favorite among investors, the word 'pension' acting as a psychological soother. The premiums are paid during a certain tenure and at vesting (retirement age), the payouts start. These payouts will however be taxed at normal rates.

There is an alternate to this. All payouts from any type of insurance plans; guaranteed, bonus linked or Unit linked are tax–free. So why not choose a whole life insurance plan with an option of year-on-year withdrawals. Such payouts are tax-free.


Courtecy: Money Control.com