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Tax-Free Investment Options in India

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Tax-Free Investment Options in India

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When considering different investment options, it's a matter of convenience to use the headline yield figures to make a comparison. But when making an investment plan, you must account for the applicable taxes since these can impact your returns in a big way. One way to reduce this impact is by investing in tax free investments.

Let’s find out which investments are tax-free and then learn to identify the best tax-free investments.

Tax free investments

The following table explains the investments exempt from income tax:

Let’s look at each investment in detail to find out which one may be the best tax-free investments for you.

Equity Linked Saving Scheme (ELSS) mutual fund

Equity-linked saving schemes are essentially equity mutual fund schemes. Investments in ELSS mutual funds up to ₹1.5 lakh are exempt from income tax. They have a lock-in period of three years. You can only withdraw or redeem your money invested in ELSS funds after three years from the investment date.

The returns are dependent on the performance of the equity markets. They may be volatile in the short term. However, they are known to provide inflation-beating returns over the long term.

You may choose from either the dividend or growth payout options. Note that, from 1 April 2018, the dividends of an equity scheme are taxable at 10 per cent. So, your investments may be more tax effective from the growth option than the dividend option.

As a beginner, you might not have a deep understanding of the stock market. But ELSS funds are managed, tracked and rebalanced by professionals known as fund managers so you don’t have to worry about it. 

These funds have the potential to beat inflation over the long term. That, combined with the income tax exemptions, makes them an attractive tax-saving investment.

ELSS funds can be good investment options for beginners with a higher risk appetite. 

Do you want to invest in ELSS? Regularly investing in small and manageable amounts through SIP might sound like a good idea. You can start your SIP investments in an ELSS fund of your choice through the Fi Money app. 

National Pension Scheme (NPS)

The National Pension Scheme or NPS is regulated by the Pension Funds Regulatory and Development Authority or the PFRDA. NPS is specifically designed to help individuals invest for retirement.

You can participate in the NPS if you are a citizen of India aged between 18 to 60 years. Fund management charges of NPS are relatively low. Hence, it is cost-effective.

Money is managed in three separate accounts having distinct asset profiles: Equity (E), Corporate bonds (C) and Government securities (G). Investors can choose to manage their portfolio actively (active choice) or passively (auto choice).

The maximum investment you can make into equity (E) is 75 percent.

Your contribution to NPS, Tier 1 account in a financial year up to ₹1.5 lakh comes under income tax exemption under section 80CCD (1B) of the Income tax act. Additionally, sub-section 1B offers an additional deduction of up to ₹50,000 for your contributions to the NPS. Together, the maximum exemption limit is raised to ₹2 Lakhs.

You should note that, in the NPS Tier 1 account, only 40 per cent of the redemption amount is exempt from income tax at maturity. It is also mandatory for you to invest 40 per cent of the corpus in the annuity plan to earn monthly income. The annuity paid to you after retirement is taxable and treated as income.

Also, you cannot make any withdrawals from your NPS Tier 1 account before your retirement unless you state an emergency need due to some specific situations in your early withdrawal application. 

The combination of equities and bonds can yield relatively better returns on investment over the long term. Since it is a government-backed tax-saving investment, the NPS provides inherent safety. Flexibility and transparency are other attractive features of NPS. Investment costs in NPS are relatively lower. You can start investing in NPS with a minimum amount of ₹500.

NPS investments are suitable for investors of all risk appetites as they can be tailored to match your risk profile.

Public Provident Fund (PPF)

PPF is a government-sponsored savings and retirement scheme. It also offers income tax exemption on the invested amount. It is especially beneficial for individuals like freelancers, contractors and entrepreneurs who do not have an employer-provided structured pension plan.

The minimum investment in a financial year in PPF is ₹500, while the maximum is ₹1.50 lakh. You may invest in your PPF account on a monthly basis or as a one-time lump sum. 

You have to invest a minimum amount of ₹500 every year; otherwise, a penalty will be levied. You can invest using any mode from cash, cheque, demand draft or online transfer. 

The Central Government of India determines the interest paid on PPF accounts. Yielding higher interest than that offered by banks is one of the objectives of PPF. The government may review and update the rate of interest every quarter. The current rate of interest on PPF accounts is 7.1 per cent (as on July 2022) and compounded annually.

The principal amount invested in PPF is income tax exempt. Additionally, the interest earned on a PPF account is also tax-exempt. And to top it up, when you withdraw the principal and the accrued interest together at the end of the tenure, the amount withdrawn is income tax exempt. This triple exemption makes it a very popular tax-saving investment scheme.

PPF as a tax-saving investment option is better suited to risk-averse investors with a long-term investment horizon.

National Savings Certificate (NSC)

NSC is a fixed income tax saving investment scheme similar to fixed deposits. You can invest in NSC at any post office. NSC is initiated and backed by the Central Government of India. This makes it a relatively safe investment. 

Investments in NSC are tax exempt up to ₹1.5 lakh in a financial year. Interest in the NSC is compounded annually and added to the principal of the following year. In the second year of investment in the NSC, you can claim a tax deduction on your new NSC investment for that year and the interest earned on the previous year’s certificate. 

Note that, on maturity, the proceeds from NSC investments are taxable.

NSC can be a good tax-saving investment option for risk-averse investors with a medium-term investment horizon.

Bank Fixed Deposit (FD) Scheme

Investments in tax-saving bank fixed deposits with a tenure of five years are tax exempt up to a maximum limit of ₹ 1.5 lakh under section 80C of the Income Tax Act. The bank sets the interest rate on the fixed deposit scheme and may review and update the same every quarter. Bank fixed deposits have a higher interest earning potential than that of a savings account. 

You may invest in the tax-saving fixed deposit as a one-time lump sum investment. Premature withdrawal is not allowed.

Tax-saving bank fixed deposits are suitable for risk-averse investors with a medium-term investment horizon.

In Conclusion

As an investor looking for income tax-saving investment options, be sure to draw an investment plan aligned to your short, medium and long-term goals and your risk profile first. Always choose investment options as per your investment plan. 

The best income tax-saving investment option for you is the one which is most aligned with your goals and your financial risk profile.

Frequently Asked Questions (FAQs)

How can I invest to avoid paying taxes?

You may invest in one of the tax-saving schemes to avoid paying taxes. These schemes provide income tax exemptions on investment amounts up to a specified limit per financial year.

What is a TFRA tax-free account?

A tax-free retirement account or TFRA is a type of long-term investment plan that’s designed to help minimise taxes on retirement income.

Which investments are completely tax-free?

The following investments are tax-exempt. The amount invested in these schemes is exempted from income tax up to a specified limit per financial year.

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