How to make the best use of Section 80C of the Income Tax Act - Motilal Oswal
How to make the best use of Section 80C of the Income Tax Act - Motilal Oswal

How to make the best use of Section 80C of the Income Tax Act

Among the many tax planning tips for salaried employees offered by tax consultants, Section 80C of Income Tax Act is among the foremost. The provisions pertaining to the investments in instruments like provident fund, life insurance, ELSS and long term FDs are extremely popular among the salaried class. But the choice is not as simple as that. There are considerations of long term returns, effective tax benefits and EET considerations that will go into your Section 80C mix. Here is how to make the best use of Section 80C of the Income Tax Act.

Step 1- Bucket the compulsory deductions under Section 80C..
As a salaried employee you will have some normal deductions that you will anyways get under Section 80C. Normally, if you are working in the public sector or the private sector it is mandatory to have a contributory provident fund where both the employee and the employer contribute 12% of the income. PFs are relatively safe and secure as they are backed by the government. Secondly, tuition fees paid for your children’s education is also eligible for deduction under Section 80C. Thirdly, your home loan decision is normally independent of your Section 80C planning. While the interest on your home loan has a separate deduction under Section 24, the principal repaid on home loan is eligible under Section 80C.For most salaried employees, the sum of employee PF, tuition fees for children and principal component of home loan constitute the default portion of Section 80C.

Step 2- Your next priority is insurance, which is a risk cover..
The second step in tax planning tips for salaried employees is to focus on risk cover required. It is always advisable to take pure-risk term covers as they cost less and give you a larger insurance cover. The premium paid on these term covers is a sunk cost but that is OK as you always must keep your insurance needs and your investment needs separate. Remember, Section 80C only covers life insurance. Other insurance covers like health policies are covered under a separate Section 80D of the Income Tax Act. Within the ambit of the balance Section 80C limit structure your life insurance in such a way that you get the maximum cover at the lowest premium.

Step 3- Post insurance look at how you can invest under Section 80C..
Once your compulsory commitments are covered and your life policy premiums are paid, you will still be left with some balance out of the Rs.150,000/- limit under Section 80C, unless you are in the higher income bracket. There are a variety of investment options under Section 80C. There are long-term FDs with 5-year lock-in where Section 80C benefit is available. However, the interest earned on these FDs is taxable in the hands of the investors. That reduces the effective yield on these instruments. Another instrument for investment is the ULIP, which is a combination of insurance and investment. The challenge in this instrument is that the loading is too high in the initial years and hence it takes nearly 4-5 years for investors to break even on these ULIPs. Also, these Unit Linked Insurance Plans (ULIPs) are not too transparent from the investor's perspective. That leaves us with the final investment instrument which is the Equity Linked Savings Scheme (ELSS). The ELSS proffers quite a few distinct advantages. Firstly, they entail a lock-in period of only 3 years. Secondly, since ELSS funds are invested in equities and there is a 3-years lock-in, the fund manager is able to take a longer-term view on investing. As a result, ELSS funds tend to outperform normal equities. Thus ELSS meets the dual purpose of saving tax and also creating wealth through equities.

Step 4- Keep tweaking your Section 80C mix based on EEE versus EET..
This is a slightly more technical argument. Section 80C of the Income Tax Act has a very important tax implication at the time of redemption. For example, in case of provident fund and insurance the investment is tax-deductible, the flows are tax free and the redemption is also tax free. Since this is exempt at all the 3 levels, it is referred to as "EEE". However, there is a plan to shift EPFs and Insurance from "EEE" to "EET". That means these products will be taxable in the event of redemption. Of course, this is not applicable to term insurance policies as they have no redemption value except in case of death. However, EET could be a potential dampener in case of EPF and other endowment insurance policies. This is something you need to factor when you decide how to make best use of Section 80C.
Section 80C of the Income Tax Act is not just about utilizing the limit of Rs.150,000/-. It is also about how best you design your Section 80C components so as to get more value for your hard earned money!
 

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