Income Tax Saving: Have you factored in the post-tax returns of your tax-saving investments?

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Updated: April 10, 2020 1:15:30 PM

When it comes to selecting appropriate tax-savers, people usually check the return prospect, risks involved, and liquidity of their chosen instruments. However, another equally important consideration is the tax-efficiency of the investment.

income tax, income tax saving, tax saving investment, post tax return, coronavirus pandemic, PPF, NPS, FD, ELSS, NSC, EEE vs EET vs ETEWhile selecting tax-saving instruments, it’s important to examine its potential for post-tax returns.

Tax-Saving Investment: The government, in a bid to assuage the economic fallout of the ongoing coronavirus pandemic, has extended the last date to make tax-saving investments for the Financial Year 2019-20 from March 31, 2020, to June 30, 2020. However, the new financial year 2020-21 has also begun from April 1, 2020. So, taxpayers should gear up to invest in the new financial year as well, especially those who would like the continue with the old tax regime and avail the many tax deduction benefits at their disposal. The earlier you start implementing your tax-saving plans, the better your chances to select the appropriate tools that are in line with your financial goals.

Now when it comes to selecting appropriate tax-savers, people usually check the return prospect, risks involved, and liquidity of their chosen instruments. However, another equally important and overlooked consideration is the tax-efficiency of the investment. If this critical consideration is not factored in, the tax obligation might eat away a major portion of the investment returns, making it difficult for you to achieve the corresponding financial goals on time. To understand this better, let’s first discuss how exactly different tax-saving investment instruments are classified tax-efficiency wise.

The EEE vs. EET vs. ETE concept

Each tax-saving instrument offers you a different level of tax benefit. There are three ways a tax-saving product may allow tax-benefits, i.e., on investment capital, on returns on investment, and on the maturity amount. Accordingly, tax-saving instruments can be divided into three categories wherein “E” stands for “exemption” (from tax) and “T” stands for “taxable”: EEE (Exempt-Exempt-Exempt), EET (Exempt-Exempt-Taxable), and ETE (Exempt-Taxable-Exempt).

So, if a product’s investment amount, returns and maturity sum are all tax-free, such a product will come under the “EEE” category. However, if a product’s investment amount and returns are tax-free but the maturity amount is taxable, such a product will come under the “EET” category. Lastly, if a product’s investment amount and the maturity sum are tax-free but returns taxable, such a product would be considered under the “ETE” category.

As such, before you select a tax-saving investment product, you should carefully evaluate its post-tax returns. So, let’s check how tax-efficient various popular instruments are to help you make informed investment decisions.

Under which tax-efficiency category do various investment instruments fall?

Tax-saving investment products falling under the “EEE” category include the Public Provident Fund (PPF), Employees’ Provident Fund (EPF), life insurance plans, traditional policies, etc. When you invest in PPF, for example, the invested amount (up to Rs. 1.5 lakh per financial year) is allowed as a tax deduction under Section 80C of the Income Tax Act, and the returns earned and the maturity pay-out are also tax-free. Hence, the scheme falls under the “EEE” category.

“EET” investments, on the other hand, include products like Equity Linked Savings Schemes (ELSS) and the National Pension Scheme (NPS). For example, on the redemption of ELSS units, the long-term capital gains (LTCG) exceeding Rs. 1 lakh are taxed at a 10% rate. Similarly, income on annuity invested in NPS is subject to tax at the applicable slab rate. In both ELSS and NPS, the investment amount and returns on investment are exempt from tax subject to the prescribed limit.

“ETE” investments include instruments like tax-saver FDs and the National Savings Certificate (NSC). In tax-saver FDs, for example, neither the invested amount nor the withdrawal sum is taxed; however, only the interest earned is taxable.

Which tax-saving instrument should you select?

While selecting tax-saving instruments, it’s important to examine its potential for post-tax returns. “EEE” investments like the PPF are the most tax-efficient instruments out there. However, if you invest in an “ETE” category product like the tax-saver FDs, the returns, i.e. the interest earned, will be taxed according to your slab rate. So, if you fall in a high tax bracket, your returns will get diminished.

That being said, apart from tax-efficiency, you should also consider other factors like returns potential, risks and liquidity of your chosen tax-saving instruments. Most importantly, your investments should strictly be in line with your financial goals. Don’t hesitate to consult your financial advisor if you need help in chalking out a pragmatic tax-saving strategy which will help you in fulfilling your life goals.

(The author is CEO, BankBazaar.com)

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