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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