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Personal Finance

Should you invest in Tax Saving Mutual Funds?

If you buy a tax saving mutual fund – an ELSS scheme or something with “taxsaver” in it – you expect a tax deduction. But does it always apply for you?

ELSS mutual funds are specially deductible under Section 80C, which applies to everybody. It really means you get a Rs. 100,000 deduction from income (i.e. taxes are calculated after this deduction) – if you spend or invest this 100,000 in some specific areas:

  • Public or Employee Provident Fund contributions
  • the New Pension Scheme contributions
  • National Savings Certificates, 5 year Bank or PostOffice Deposits, NABARD Bonds
  • Insurance premium (Premium < 20% of sum assured)
  • Mutual Funds (ELSS)
  • School fees for two children (includes Pre-school fees, yay!)
  • Principal repayment on a housing loan (or full/down payment on a house)

They all come clubbed in the same 100,000 deduction – meaning if any combination of the above goes above 100,000 – then that’s all you get. First, find out if you’ve already exceeded the 100K deductible. If you have, don’t bother reading ahead.

Since you haven’t yet finished it all up, find out if you’re adequately insured. Hundred of insurance sites have them – for an IE only (no firefox) quick plan, check out this site. Then buy the plain term plan – Religare’s iTerm Plan, sold only online, is the cheapest by a LARGE margin. (I will pay Rs. 21K for a 25 year 1 crore policy, where the average other policy is 33K)

Do not buy ULIPs. They are evil.

If you still have anything left in that 100,000 tax deduction, you might think of ELSS mutual funds. Now you might be in for a surprise with the Direct Tax Code coming into force in 2011.

The DTC moves to an EET regime – Exempt on entry, Exempt on accumulation and Taxed at exit. ELSS is currently EEE – you save tax when you enter, and because of the STT benefit you pay no tax on exit. That will change – after 2011, any exit from an ELSS fund will be treated as “capital gains” and taxed in your tax bracket. If you buy an ELSS fund, the earliest you can exit is 2012-13, by which time the DTC will be active (and yes, it will apply to your old investments as well, unless they change the current draft)

The DTC even charges the withdrawal on the principal (not just the gain) – but it’s currently hazy about whether it will apply to past investments. Dhirendra Kumar at Value Research thinks that it will not apply to past investments and the draft code will be changed. Still, there’s a risk this works against you.

If you really need most of the money back in three years, buy a PPF/EPF instead – at least that has no tax on principal & interest till March 2011.

But the ELSS fund investment is a long term one and in all likelihood you can retain it for several years, only taking out what you might need. Even with tax, the gains from equity may be substantial, and high enough to outperform the PPF/EPF rates (the NPS has done 14 and 11% in the last two years; most ELSS schemes are just about where they were two years back)

With the higher mutual fund commissions too, their future returns are suspect. But I’d say this – it’s probably a better bet to go with a good tax saving fund and keep the money in there till you retire. It’s a good long term saving system with enough liquidity that you can take it out anytime after three years, but won’t because it’ll get taxed. And if you don’t need the money, then please use the NPS – the ultra low management fees juice up the returns substantially.

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  • DK says:

    >Thank you for your post (and granting my wish 🙂 )

    I had not heard of NPS. I am still researching it, but liquidity might be a problem.

    I usually invest in ELSS, but some of my ELSS investments since 2007 have yet are still in the red.

    Using ELSS for retirement planning is akin to buy and hold isnt it? And you have shown enough times in your blog that B&H doesn't always work.

    Another thing about insurance. I have always adviced (advised?) my friends to get themselves term insurance.
    Quite a few of them don't really think they need 1 crore as cover.

    Have you touched upon inflation adjusted returns in the past?

  • Nilesh says:

    >hay one question.
    does housing loan tax benefits (1.5lakh interest and 20k in interest) will not apply in FY2010-2011 ?

    i heard there was some proposal for the same.

  • Amit says:

    >I have a bit different perspective on using ELSS for tax saving by investing in funds which give blockbuster dividends. These dividends are still not taxable & can be used until new tax code comes into play. The details are on my blog – http://www.finwinonline.com/

  • Madhab says:

    >I think NPS is yet to come under 80C, isn't it? Probably this is the reason it's subscriber base is very low.

    Another query, I have opened a PPF account on my wife's name. Do I get tax benefits if money is deposited in that account. I have read the same in various websites, but didn't get any concrete proof. My office CA is unwilling to accept this.

  • Arghya says:

    >Many a thanks for making time for responding to my request. Earlier I used to admire you now I have a different level of respect for you. There are many knowledgeable persons but very few of them are respectable ….

    Thanks for mentioning Ageon-Religare website. It’s just wonderful. The best thing I like about them is the idea of minimizing the role of insurance-agents; probably this is why they could have such a difference with their peers.

    Currently I am having a term insurance with MaxNewyorkLife of Sum-assured of 50lac for which I pay 13400. I took it at the age of 24 and it is in its 4th year. I am also thinking to add the maximum amount (they said only 30% premium could be for accidental benefit) of accidental benefit to this policy. Do you think it would be good idea to switch to Ageon-Religare at this stage?

    I want to add a point here for everybody – Please make sure to add the raider “Accidental Death Benefit” always to the maximum limit. Because it’s very cheep (around 150@lac). And I think probability of early death by accident is much higher than other cause.

    No comment regarding DTC. There are so many questions.

    Regarding ELSS, again I want to add one more point – I think in case of ELSS investment we should always go Dividend option irrespective of our liquidity requirements. Logic is – Usually when we get better return on stocks, MF’s usually give high dividend. And obviously when stocks returns are high it means it has already entered into an overvalued-danger zone. High dividend at this point is a blessing. So I think dividend option in MF’s is always better than growth option.

    Regarding NPS – could you please elaborate a little bit? Links etc. How to buy, where to buy?

  • arghya says:

    >@Madhab

    NPS comes under 80CCD.
    http://www.business-standard.com/india/news/everything-you-want-to-know-aboutnew-pension-scheme/356860/

    Regarding PPF account on your wife's name — Yes you should get tax advantage as long as she is dependent on you. And remember if she is dependent on you, any gain on that account is taxable on your hand, it is just get clubbed with your income. Anyway I must tell you that my funds are also from internet .

    I think it depend on company to company. Even though now there is no need to provide proof for LTA, my company has asked me for it. You know can’t argue with your company after a certain point. At best you can request your office CA to deduct less TDS tax and issue a form 16 based on that. And when you file return you claim the portion you have invested on your wife’s name. Or you can opt for tax-refund which I would suggest to avoid.

  • Bingo says:

    >Religare? The insurance industry in India is unregulated. Or rather, negatively regulated because IRDA speaks more for the benefit of the insurers than that of the insured.

    In such a climate, suggesting a new-fangled insurance scheme is very short sighted. No-one knows the claim settlement experience of this scheme. And it will be different from other schemes, since there is no agent here.

  • Manish Chauhan says:

    >Deepak

    Good post on ELSS .Regarding term insurance, Even I have posted a review on my blog and there was a big "halla bol" on my blog regarding iTerm . Seems like the customer care of AR is not very good and people think that its a cheap chinease product ,which I do not think personally

    AR has come up with products which are mainly focused on Term policy which our country needs and may be because of high load and response their customer service could not take load .

    I talked to the officials here and got all this info .

    As per IRDA report for this year(2008-09) . they have not 5 rejected claims and 2 pending ones out of 7 claims recieved. I never say this means that they are bad .

    But waiting for some time and then take the policy from them is what I am suggesting everyone . But I personally would like to go with them right now , because 4,100 for a 50 lacs cover is worth the risk for me 🙂

    Here is the iTerm review incase your readers would like to read : http://www.jagoinvestor.com/2009/11/iterm-cheapest-term-insurance-from-aegon-religare.html

    Manish

  • Bharath says:

    >Thanks a lot !! I never knew that ELSS will be taxable from FY12.

  • Ganesh says:

    >@Arghya About your comment on accidental insurance – You said its cheap at Rs 150 per lac.

    Accident Insurance is a must have. No doubt. But i think Rs.150 per lac is still expensive. Where did you get that figure from?

    Safe Guard, a co-branded Personal Accident Policy from Axis Bank/ Bajaj Allianz costs only Rs.990 for 10 lacs (Rs.99 per lac). I am sure that the amount will lesser for General Insurance providers.

  • Anonymous says:

    >One question regarding PPF.
    http://www.rediff.com/getahead/2005/may/06ppf.htm
    Have a look at the article, I know it is slightly old, however, I do not think anything changes w.r.t. PPF in 5 years.
    Please read "How to make it work to your benefit."
    What they are saying is that interest is calculated only in the month of March. I find it very surprising if that is the case. And I typically put 70k in April itself so am I effectively losing money? Typically I do not trust rediff articles, so just wanted to know your opinion

  • Deepak Shenoy says:

    >DK: Not yet – inflation adjusted returns is a darn good idea really.

    Nilesh: Yes, the housing loan benefits may be withdrawn. Let's see how the direct tax code changes before it's adopted.

    Amit: Those dividends are nearly all gone, but good points. I wrote about them on this blog earlier too, and thanks for reminding me.

    Madhab: I think NPS is under the same limit (through 80CCD) but there aer some other issues when you are not employed etc.

    Arghya: Thanks for the clarification, and I'll post something on NPS soon.

    Manish: I agree, must hold on to the iTerm plan until more data emerges.

    Ganesh – you are right, I got a 30 lakh accident cover for 3K, which is about 100 per lakh.

    Anon: PPF calculates interest at the end of every month (lowest bal betn 5th and 25th) – that article is slightly misleading.

  • Anonymous says:

    >dear all,
    wellcome.
    i fully agree with mr. bingo.
    stay away from very complex ulips.
    i donot think taking a pure term plan from online is a good idea.
    thanks for this service.