What’s on the menu for tax savings

What’s on the menu for tax savings

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A look at the various options available to investors, in terms of risk and return potential.

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Available, a wide range of options.

Amit Thakkar

Death and taxes are a certainty. Financial planning takes care of both of them. Earlier, tax savings were done out of compulsion, mostly in the last quarter of the financial year. But today, the scenario has changed.

Investors now plan their tax affairs and investments after considering the return potential. Generally, any investment should be weighed and assessed in three contexts.

Security/risk.

Liquidity.

Finally, returns.

Investment if not secured, or risk if not managed, can create pitfalls for the investors. Liquidity ensures the availability of funds. Returns should be strong enough to beat the inflation and fulfil other financial objectives. Therefore, one should apply all these tests before choosing from the tax-saving options available.

Under section 80C of the Income Tax Act, tax deductions are available for the following investments:

Life Insurance premium paid for policy. Eligible assesses are individuals/ HUFs.

Sum paid under contract for deferred annuity.

Contribution to Employees Provident Fund.

Contribution to Public Provident Fund.

Contribution to Recognised Provident Fund.

Contribution to approved Super Annuation Fund.

Subscription to any notified security or notified deposit scheme of the Central Government.

Contribution to Unit Trust of India for Unit Linked Insurance Plan.

Principal re-payment for housing loan.

Subscription to any notified saving certificates.

Subscription to any units of a notified Mutual Fund or the Unit Trust of India.

One should weigh and assess these deductions on the criteria of returns/safety/liquidity.

PPF (Public Provident Fund)

This is a popular investment. At present, it gives 8 per cent tax-free returns, which is as good as 11 per cent pre-tax returns for an individual who is in the highest tax slab of 30 per cent.

It is fully secured and offers guaranteed and timely returns. However, it is not very liquid and the scheme is for a period of 15 years, which is further extendable for five years.

Withdrawals are possible only from the seventh year.

INSURANCE

Insurance cover needs should be carefully assessed according to the life stage of a person and other factors.

Family size, children’s needs, earnings levels and encumbrances are factors one has to consider while deciding on the extent of the cover. It is advisable to separate Insurance from investments.

Any insurance product has, apart from mortality charges, high administrative costs, which also applies to the investment component of insurance.

Term Insurance can be an appropriate and necessary instrument for a young family with children .

One has to carefully assess one’s requirements before committing oneself because such products have a very long tenure and fixed payments.

Equity Linked Saving Schemes

ELSS is a tax saving Mutual Fund. If the risk tolerance of an investor is high, it is an ideal saving instrument for wealth creation. It scores very well on liquidity. It has only a three-yearlock-in period. Further, if you opt for the dividend plan, it can start giving you tax-free returns immediately. As maturity is not until three years, capital gains from such investments are also tax free.

Historic returns from such products have been high for three-and-five-year horizons. The risk in ELSS can be managed by opting for SIP (Systematic Investment Plan) mode. SIPs are a way to ride out the volatility of the stock markets. However, those who are retired and have a bare minimum of funds should not consider it.

National saving certificates

This is also a savings instrument managed by the Post Office. Interest income from the same is taxable because the deduction under section 80 L has been withdrawn.

As the horizon for investment is eight years, it is not that liquid. But it is a secured investment issued by the Government.

FIXED DEPOSITS WITH SCHEDULED BANKS.

With effect from 2007-2008, FDs with scheduled banks for a term of five years, if notified, are eligible for tax deductions.

This option is very suitable for retired persons, widows and others with a low risk appetite.

Due to the recent rise in interest rates, this option offers decent returns and also scores high on the yardstick of security. But interest receivable is taxable.

Tax savings — Higher returns, optimal portfolio

Tax savings — Higher returns, optimal portfolio

Suresh Krishnamurthy

IN THE end, the Budget proposals must have come as a pleasant surprise to salaried taxpayers and the self-employed, especially the latter. The expected overhaul of personal tax laws has not increased the tax incidence, and taxpayers have ended up with a pretty fair deal. The proposals will result in lower taxes, whether you save or not. If you save, you will gain more.

The crucial change, which can galvanise personal investing, is the introduction of a consolidated limit of Rs 1 lakh for all tax-saving investments without any ceiling on individual options, and for certain expenditure items.

Portfolio allocation, however, can now be optimised, with a certain proportion reserved for equity . There is no need to hold a portfolio separately for tax savings and another for other investments. This could increase returns significantly.

The present dispensation should, however, only be viewed as a window of opportunity that will close any time.

The changes represent the first steps in the transition to a state in which investments that earn tax savings will be taxed at the time of redemption. As things stand, investments which earn tax savings are not taxed at the time of redemption. Investors, as such, need to be on guard and should not fritter away the advantage by investing in low-return options. They particularly need to guard against aggressive marketing of sub-optimal insurance plans.

Limited options

Until now, investors suffered from a severe dearth of options. Consider this.

The just-concluded public offer of bonds by IDBI attracted subscriptions of Rs 2,100 crore when the offer size was only Rs 800 crore; the coupon on offer being less than 6 per cent. This is because you had no option if you wanted tax savings from infrastructure bonds.

In the year ahead, however, you need not restrict yourself to these bonds. You could invest in pension plans of mutual funds and insurance companies or in small savings schemes. These options offer significantly higher returns than infrastructure bonds.

Even the National Savings Certificate, which offers an annual return of 10.4 per cent for investments made after the new tax laws come into effect, offers a better deal than infrastructure bonds. The yield-to-maturity of infrastructure bonds, such as those issued by IDBI, even under the existing laws, was lower at about 9.4 per cent. If the coupon rate remains unchanged, the yield will plunge to 8.2 per cent under the new laws.

In the proposed tax structure, the NSC is a sub-optimal option as the interest accrued each year would be subject to tax. Investment options such as provident fund that provide tax-free interest will fetch higher returns. Employee provident fund, for instance, can fetch returns of about 12 per cent.

Expenditure: First claim

Before making investments to get the benefit of tax savings, however, you may want to use the specific expenditure that is allowed as part of the limit of Rs 1 lakh. This will help you get tax savings when your annual investments are less than Rs 1 lakh. The list of such expenses includes:

Stamp duty and registration fees paid at the time of purchase of house property, Repayment of principal on existing and new home loan, Tuition fees paid in respect of child (It is not restricted to two children. If you invest Rs 1 lakh or more each year then it does not matter. You will get the entire benefit even without having to show the expenditure as part of the limit. If such individuals were in the 20 per cent tax bracket, the tax benefit would reduce the cost of a 9.5 per cent fixed rate home loan to about 6 per cent. If they are in the 30 per cent tax bracket then the effective interest rate would come down to about 4 per cent. If the fixed rate is 9 per cent, then the effective interest rate would come down to 3.5 per cent for an individual in the 30 per cent tax bracket. Equity or not If employee provident funds can fetch me after-tax returns of 12 per cent per annum, do I need to invest in equity at all? This is a legitimate question, especially for investors with either a lot of money in their hands or none at all. Equity is appropriate for these investors, too. Consider the risks involved in EPF or PPF. The rate of interest could fluctuate and could trend lower over the next few years. If liquidity in the system keeps rising and the economy is in good shape, then the interest rates offered by these schemes could dip. Importantly, EPF managers themselves are looking to invest in equity to sustain the returns at higher levels. In addition, it would be appropriate to compare the returns of equity and debt without tax benefits. For instance, EPF offers you 9.5 per cent and PPF 8 per cent. But with the economy poised to grow steadily over the next few decades, return expectations of about 12 per cent from equity do not seem unjustified. Optimal portfolio First, for most investors, there is no need to consider a portfolio for tax savings and another for non-tax saving. This is true if they have a long-term perspective and the schemes they invest in are largely restricted to provident funds, pension funds offered by mutual funds and insurance companies. This is also the case for most investors who lack the expertise to invest in stocks directly. Incidentally, there are only a couple of pension funds offered by mutual funds now. The array of available options is, however, likely to increase significantly over the next year. In this backdrop, allocation of 50 per cent to balanced fund options in pension plans of mutual funds and insurance companies appears optimal. It would peg an investor's exposure to the equity market at 20-25 per cent. This would enhance returns and also appeal to the conservative mindset of most investors. The rest can be invested in provident funds and pension plans that invest their entire assets in debt investments. If they have a shorter-term perspective of less than 10 years, then they can consider investing 40 per cent in mutual funds and split the rest between small savings and provident funds. While investing in the pension plans of insurance companies, taxpayers should ensure that their purchase of term insurance is not more than what they need. If you buy more term insurance than what appears justified under the circumstances, it will only act as a drag on returns. If you want to invest more than Rs 1 lakh and prefer debt options, you should seriously consider debt mutual funds. This is because the Budget has eroded the competitiveness of the POMIS significantly. Its yield-to-maturity under the new dispensation — with interest not deductible under Section 80-L — comes down to 7.5 per cent, as against 9.3 per cent earlier. With yields on corporate debt inching higher to above 7 per cent, tax-efficient and liquid debt mutual funds can offer competitive returns.

Financial Trends Analysis

Financial Trends Analysis

October 2006 Annual Financial Trend Analysis (pdf/865kb/62pgs)

Each year the City of Scottsdale evaluates its current financial condition with existing programs, assesses future financial capacity, and integrates short- and long-term plans, City Council goals, objectives, and financial policy into its decision-making process. Analysis of the City’s financial and economic trends is an integral part of this process.

City staff performs financial trend analysis each year in conjunction with the annual audit and financial report preparation. The annual Financial Trends report combines budgetary and financial information with economic and demographic data to create a series of local government indicators to monitor changes in Scottsdale’s financial condition. These indicators, when considered as a whole, can help interested stakeholders gain a better understanding of the City’s overall financial condition. The report also provides information regarding existing and potential environmental, organizational, and financial problems that may affect the City’s future fiscal health. This type of analysis of key financial trends and other community factors is similar to the analysis that credit rating agencies undertake to determine Scottsdale’s bond rating – AAA.

Using this trend analysis and the framework of the financial policies adopted by City Council will enable management to strategically plan and budget, provide solutions to negative trends, and ultimately preserve the financial health of Scottsdale. It is a good ‘report card’ of the City’s current financial condition and reference point as staff begins work on the next year’s financial plan (budget).