Tax season 2024: Where should you invest? Best tax-saving options for you

It's that time of the year when many of us who have opted for the old tax regime are scrambling to find investments to lower our taxes. With so many investment choices out there in the market, how does one pick the right option? Business Standard helps you decode the right strategy for you. 

When considering any tax-saving investment, you must know about the alterations in income tax regulations effective from April 1, 2023. Commencing from the fiscal year 2023-24, the new tax regime has become the default tax regime. Under this new regime, the basic exemption limit has been raised to Rs 3 lakh from Rs 2.5 lakh.

As tax season approaches in India, it's crucial to explore various investment options that offer tax benefits and align with your financial goals, especially if you have opted for the old regime. Section 80C offers a window of tax saving investment opportunities for up to Rs 1.5 lakh investment. If you are in the highest tax bracket of 30 per cent, the investment of Rs 1.5 lakh under this section will save you Rs 46,800 each year. The various financial products that qualify for Section 80C benefits are as follows:

1. Life insurance premium payment
2. Repayment of home loan principal 
3. Your contribution to Employees Provident Fund (EPF) (employers' contribution is not deductible)
4. Tuition fees for up to two children. However, any payment towards any development fees or donation to institutions is excluded. Also, the aggregate deduction under section 80C should not exceed the overall Rs 1.5 lakh limit. Contributions to the Public Provident Fund (PPF)
5.  Investments in the Senior Citizens Savings Scheme 
6. Savings in notified term deposits in scheduled banks with a minimum period of five years under the bank term deposit scheme
7. National Savings Certificate, five-year government-backed security available at post offices
8. Investments in tax planning mutual funds (ELSS)
9. Investments in pension plans

As per Value Research, an effective way to determine which tax-saving investments are tailored to your needs is based on three factors:

1. Time horizon of the investment
2. Risk appetite
3. Liquidity (How easy it is to withdraw the money)

Life insurance should be your priority 

Life insurance comes first, especially if you have financial dependents. Consider it as a cost to protect the financial future of your loved ones. " You must buy only a term insurance plan. The premium that you pay is eligible for tax benefit under Section 80C. Do not opt for endowment insurance plans or unit-linked insurance plans (ULIPs), which claim to provide the twin benefits of insurance and investment. As you get closer to the deadline, these two products will be pitched to you in a big way. However, don't get influenced to buy them. Keep it as simple as possible when it comes to insurance. Buy a cheap term plan with an adequate insurance cover," said Aakar Rastogi of Value Research. 

Equity-linked savings schemes (ELSS) and National pension scheme (NPS) will help you create long-term wealth

Tax savings mutual funds offer tax benefits under Section 80C of the Income Tax Act. These funds offer the dual advantage of tax savings and potential capital appreciation. Since ELSS funds invest in equity and equity-related instruments, offering the potential for higher returns compared to traditional tax-saving options. However, this also entails higher market-related risks. Despite short-term market volatility, ELSS funds allow you to generate wealth over the long term due to their exposure to equity markets and the power of compounding. 

"Investments in ELSS qualify for tax deductions of up to Rs. 1.5 lakh under Section 80C of the Income Tax Act. This deduction reduces an investor's taxable income, leading to lower tax liability. They come with a mandatory lock-in period of three years, which is the shortest among all tax-saving investment options under Section 80C. During this period, investors cannot redeem their investments. Upon redeeming after three years, you are liable to pay a long-term capital gains tax at a rate of 10%. However, if the gains fall within the threshold of Rs 1 lakh, no tax is applicable," said Adhil Shetty, CEO of Bankbazaar

On average, ELSS funds have yielded a long-term return of over 15%. Assuming a return of 15% from your ELSS investments, a monthly investment of Rs 15,000 over 15 years would help you save a corpus of slightly over Rs. 1 crore.

"ELSS stands out as a superior tax-saving investment against tax-saving FDs, offering tax benefits, the potential for getting inflation-beating returns, and greater liquidity. It gives investors the dual advantage of tax savings and wealth creation, making it a compelling choice for those looking to build a diversified portfolio with long-term growth potential," said Chatradhar Paritala, Executive Director - Wealth, Client Associates.

How to make the most of this investment? 

"To make the most of investments, aligning them with your financial goals and risk appetite is crucial. Due to its exposure to equity markets, ELSS offers potentially higher returns than tax-saving FDs, especially over the long term. For example, while tax-saving FDs may offer fixed returns of around 5.5%-7.75%, ELSS has historically delivered returns averaging 12-15% over the long term, depending on market conditions. In addition to this,for the tax-saving FDs, the interest accrued is taxable at the individual's slab rate, but in the case of ELSS, the long-term capital gains tax is 10%, which makes the latter more attractive even from a post-tax basis," said Chatradhar.

Is ELSS the best bet?

" If you give them at least five years, they have generally provided double-digit returns. For instance, even the average ELSS has delivered over 18 per cent annual returns in the last five years as of February 27, 2024. That's because the volatility associated with equity usually flattens if you stay invested for at least five years.In short, ELSS should be part of your long-term portfolio, regardless of whether you are a conservative or an aggressive investor.

But please note that although ELSS has the shortest lock-in period of three years,  that's not long-term when investing in equity. A three-year investment period can be fraught with market volatility. It would help to have at least a five-year outlook to optimise your equity investments fully," noted Value Research in a note.

What should the investment strategy be? 

"You can simply subtract your mandatory deductions, such as the EPFO and the life insurance premium from the available limit under Section 80C and invest whatever is left in one or two good ELSS funds. They are transparent, well-regulated products and offer great long-term return potential. They also happen to have the shortest lock-in period (three years) among all tax-saving alternatives. However, you should ideally plan to remain invested for longer to benefit from their superior return potential," said Rastogi. 

What about NPS? 

The National Pension System or NPS (Tier I) comes with strong merits like extra low expenses, and additional tax benefits but has a lock-in period till retirement. Even though this may seem like a disadvantge, it is a blessing in disguise for investors who find it difficult to be disciplined with their retirement savings. 

"NPS will lock your money in till you reach the age of 60. However, partial withdrawals are allowed before that only under specific circumstances. Moreover, you will necessarily have to buy an annuity product with at least 40 per cent of the money you receive at the age of 60. The charm of NPS lies in the fact that it helps you avail an additional deduction of up to Rs 50,000 over and above the Rs 1.5 lakh limit offered by Section 80C," said Rastogi.

NPS offers tax benefits under Section 80C and additional tax benefits under Section 80CCD(1B). You are eligible for a tax deduction of Rs.1.5 lakh under Section 80C. Additionally, under Section 80CCD(1B), you can claim a tax deduction of up to Rs.50,000, along with overall limit of Rs.1.5 lakh. So in essence, NPS allows you to claim a tax deduction of up to Rs 2 lakh under the old tax regime. The others have a limit of Rs 1.5 lakh only.

Public Provident Fund (PPF):

PPF provides tax deductions under Section 80C and offers fixed returns along with tax-free interest accrual. Consider the current interest rate, flexibility, and long-term investment horizon when selecting PPF.

"PPF is a 15-year product and over such a long horizon, ELSS funds work out to be the best because of their better return potential. But those who get easily unnerved by the ups and downs of the equity market can consider investing some portion of their tax-saving allocation in PPF. Among the fixed income options, it is clearly ahead of others. A tax-free return of 7.1 per cent (though it is subject to quarterly revisions) is quite attractive for an assured return instrument," noted Rastogi. 

Other alternatives

Tax-saving FDs provide tax deductions under Section 80C, but the interest earned is taxable.  Sukanya Samriddhi Yojana (SSY) is a savings scheme for the girl child, offering tax benefits under Section 80C. Evaluate the interest rate, tenure, and withdrawal rules to determine if SSY suits your investment needs.

"ELSS, NPS and PPF usually take care of the tax-saving requirements of most individuals. However, those who are still looking for a fixed-deposit kind of product with a shorter maturity period  can consider National Savings Certificate (NSC). Of the three options available here (the five-year post office deposit and the five-year bank FD being the other two), NSC wins because of its better return and the sovereign guarantee," said Rastogi. 

What about Senior Citizens' Savings Scheme (SCSS)?

This option makes sense for a regular-income-seeker above 60 years as the  8.2 per cent per annum it currently yields is higher than any other fixed-income alternative. "It is also the safest option, as it comes with a sovereign guarantee and offers regular interest. Although the interest income is taxable, senior citizens above 60 get tax exemption for up to Rs 50,000 interest earned in a financial year. The only downside is that it has a maximum limit of Rs 30 lakh per subscriber. It is Rs 60 lakh in case of joint holding with your spouse. Once that limit is exhausted, the investor cannot make incremental investments. So, one cannot rely on SCSS for tax savings year after year," noted Value Research.

How to save tax apart from Section 80C 

Apart from 80C, various other provisions allow deductions  to taxpayer as follows :

1. 80D- for medical insurance premium for self, spouse &  dependent parents. 
2. Section 80EE – Deduction  for interest payment of home loan for first home owners
3. Section 24- Interest deduction for housing loan upto Rs 2 lakh
4. Section 80EEB- interest deduction for vehicle loan for purchase of electric vehicle
5. 80G- donations to charitable institutions. 
6. 80GG-if your income does not include HRA component, you can claim rent deduction under 80GG
7. Section 80TTA- deduction upto Rs 10,000 for interest received in saving bank account. 
8. Section 54 -54F – Capital gain exemption for capital gains.