Making the best use of section 80C for tax saving: an example

Published: August 9, 2016 at 8:53 am

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We all that know that one can invest up to Rs. 1.5L under section 80 to save tax*. However, are we making the best use of section 80C for tax saving? Have we cluttered the portfolio in the name of saving tax? Is tax saving an integral part of our goal planning portfolios? Here is an example of making the best use of section 80C. This is the model adopted by Ashal Jauhari, the owner of Facebook Asan Ideas for Wealth and India’s best financial literacy proponent.

(*) Many believe that they are saving Rs. 1.5L tax by using 80C. The taxable income can be reduced by Rs. 1.5L using section 80C financial instruments. The actual tax saved depends on one’s tax slab: 1.5L times tax rate.

Utilizing  mandatory expenses for  section 80C tax saving

Tuition fee/School fee/ Education fee for children: The entire Rs. 1.5L limit is available for deduction for up to two children.

Term Life insurance premium: Any life insurance premium (ULIP, moneyback etc.) can be used for deduction. However, since one should not mix insurance and investment, I prefer to term life insurance as the only mandatory life insurance.

Home Loan Principal Repayment: The principal component of your home loan EMI can be claimed under section 80C. To calculate this principal component, you can use this Excel Home Loan Amortization Schedule Template

Utilizing  mandatory investments for  section 80C tax saving

These are  the well-known EPF or NPS contributions (employee contribution). Read more: Do Not Invest Rs. 50,000 in NPS For Saving Tax!

For Ashal, the above avenues constitute his section 80 tax saving.  BY intelligently utilizing mandatory expenses and investments for tax saving, he avoids instruments like PPF which come with an extended (15 financial years) lock-in period. His investible surplus can be utilized in a desirable asset allocation. Read more: Deciding on asset allocation for a financial goal

Other possibilities

School fees and home loan principal component do not apply to everyone. In that case, investments are necessary.

Here is a way in which once could plan.

  1. Determine amount needed for retirement goal. You could consider using the Low-stress retirement calculator with flexible asset allocation. Let this be a nice round Rs. 25,000 per month.
  2. Let term insurance premium be Rs. 9,000 per year. Thus Rs. 1,41,000 needs to be accounted for via investing. This includes EPF as well.
  3. Now, Rs. 11,750 a month has to be invested for maximizing section 80C deduction. Let total EPF contribution be Rs. 5,000 a month. Now. Rs. 6750 has to be invested saving tax.
  4. Let us assume an asset allocation of 60% (of Rs. 25,000) in equity and 40% in fixed income.
  5. Amount to be invested in fixed income is Rs. 10,000. Out of which Rs. 5,000 is already invested in EPF.

Here is a possibility (all values per month):

Section 80 Tax saving:

Rs. 5000 in EPF
Rs. 5000 can be invested in Voluntary Provident Fund*

Rs. 1750 can be invested in ELSS mutual funds

Non-tax-saving investments for retirement

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Rs. 13, 250 in non-ELSS mutual funds.

This will ensure a total of Rs. 11750 is invested in Section 80c instruments and Rs. 13,250 (to reach Rs. 25,000 limit) in non-ELSS mutual funds.  The asset allocation is preserved for the retirement goal.

Another possibility (suggested for young earners).

Section 80 Tax saving:

Rs. 11,750 in ELSS mutual fund and Rs. 3250 in non-ELSS mutual funds.

Rs. 5000 in EPF

Non-tax-saving investments for retirement

Rs. 5000 in VPF or PPF (as desired). This will not count for tax saving.

Alternatives: This Rs. 5000 can also be put in arbitrage mutual funds to earn tax-free returns (as of now). This would count as part of  debt asset class. Do not use if you do not understand the asset class. Long-term returns may not beat PPF or EPF.

Or if one does not mind paying a little tax, debt mutual funds. Again long-term returns after tax nay not be higher than PPF.

Note: Each SIP installment in ELSS mutual funds would be locked in for  3 years. You can alternatively set up quarterly SIPs or invest the equivalent amount once or twice a year. Use only until needed.

Also, Do not use ELSS mutual funds for last minute tax saving

Conclusion

  1. Take advantage of mandatory expenses for saving tax under section 80 C.
  2. Associate tax planning with a long-term financial goal like retirement.
  3. Some of the investments chosen for such a goal can be tax-saving instruments.
  4. Invest such that the asset allocation for a goal is not disturbed.
  5. Do not choose any tax-planning instrument unnecessarily.
  6. Do not invest Rs. 1.5 Lakh in PPF. Focus on Asset Allocation instead
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