In India, most investment decisions are taken keeping ‘tax-savings’ in mind.
Saving taxes is important.. but its not enough.
I have myself realized this quite late (but luckily, not very late).
No doubt you should try to maximize your tax savings using various sections of income tax laws (like Section 80C, 24B, etc.), as it puts more money in your pocket to do whatever you want to do with it.
And why not? After all its your hard earned money.
But more often than not, tax-saving investments tend to happen without much thought. People generally start asking about how to save taxes using Section 80C, at the last minute.
And that is not smart.
Result is that people give priority to saving tax alone instead of selecting the right financial product as per their financial goals. And that is where they step on the wrong financial path.
If you want to get rich or want to achieve some important financial goals, then tax saving will neither make you rich nor help you achieve those goals. For that, you need proper planning and more importantly, discipline to stick to the plan.
Tax saving will always be a side effect of a proper financial plan. It will never be ‘the’ plan in itself.
Now I have already written in detail about why Tax saving is not sufficient and why you need to do proper investment planning. So I won’t go down that line again…
Instead, what triggered me into writing this post is that I get several mails from young readers who want to know the best strategy to save taxes. Their queries range from asking for tax saving tips for salaried employees to wanting to know the best tax saving options for their age groups.
They are rightly worried about saving taxes and I am glad that they know it is important. They are technologically smart enough to use income tax calculators to do online efiling of taxes themselves, if need be. But many of them don’t realize the gravity of the fact that various tax-saving products do more than just tax savings – They invest your money for future returns too.
So it is very important to not be on a lookout for just the best tax saving strategy.
Instead, being young these people should focus on choosing the right investment products based on their goals, horizon and risk appetite. Tax saving comes later.
Always remember that that investing properly in right assets has a far greater role to play in your get-rich plans. Saving taxes alone won’t make you rich.
If you are Young, You are Lucky!
The best thing about being young is that one can make financial mistakes and still get back on the right track – as one has several years (or decades) in front of them.
So if someone starts working at the age of 21-22 and is mismanaging their money till say 30, then they still have another 25-30 years left to get it right.
On the other hand if someone is bullshitting with their money till 45-48, then there is not much time left (only about 12-15 years). It is very difficult to correct the mistakes of past so many years.
So being young has an inherent advantage, even when the earnings during that time are low (and here is the big proof).
So coming back to the young earners, what is it that they can do to invest wisely as well as save taxes
Section 80C to your Rescue
The Section 80C offers various investment-cum-savings options to people – which not only generate returns but can also be claimed as deduction while calculating taxable income.
Currently, the total maximum deduction under Section 80C is Rs 1.5 lac.
This means that you can reduce your taxable income by upto Rs 1.5 lac every year, if the amount is invested or spent on any of the options that are covered under the Section.
Depending on your tax bracket, this can mean a saving of Rs 15,450 or Rs 30,900 or Rs 46,350 for tax brackets of 10%, 20% and 30% respectively.
So what are various options under Section 80C for young earners?
There are several:
- EPF (Employee Provident Fund) – Generally, the salary is automatically deducted for contribution towards EPF. But only your and not your employer’s contribution will qualify for deduction under Section 80C.
- VPF (Voluntary Provident Fund) – Any additional contribution you make above the required EPF contribution is taken as VPF.
- PPF (Public Provident Fund)
- ELSS Funds
- Life Insurance Premiums (Avoid Endowment & Moneyback Insurance Policies. Choose plan Term Plans)
- 5-year bank FDs
- Principal Repayment on a housing loan
- NPS (National Pension Scheme) – You can invest up to Rs 50,000 in NPS for additional tax benefit under Section 80CCD (1B). So total tax benefit can go up to Rs 2 lacs.
Too many options!
And I haven’t even listed all of them. I have just mentioned those that are more suitable for young people.
So how do we shortlist from these options?
The first step is to cut out the noise and focus on young people’s goals and asset allocation.
So ideally, these people are those whose retirement is almost 30 years away. For such a time horizon, one should invest a major chunk of investible money in equity or equity-linked products.
Equity is the clear winner when it comes to generating best post-tax returns in the long term. More importantly, equity can beat inflation comfortably and that is what you want to do.
What Should Young Earners Do?
Answer is – Keep it Simple.
One should maintain a reasonable diversification among Section 80C investments. But no need to invest in too many products.
So if you are young and want to invest money towards your retirement (or better still, early retirement and financial independence), then following two products are sufficient from investment + tax saving perspective:
- ELSS (Equity Linked Saving Scheme) – (Asset Class – Equity)
- PPF (+ EPF if you have that) – (Asset Class – Debt)
ELSS are tax saving mutual funds that have a lock-in of 3 years. Some of the best tax saving mutual funds have given 15-18% average annual returns since inception. So that is no brainer when it comes to returns.
To bring stability and diversification, debt has to be a part of long term portfolio. EPF + PPF do that job very well. EPF is mandatory for most salaried people. If your EPF deductions are not sufficient, you can go for PPF (or VPF in your organization).
Now you may ask how much to invest in each of these two assets.
The answer ideally depends on one’s risk appetite. So if you don’t like to take risk, then invest more in EPF/PPF/VPF. If you are comfortable taking risk, invest more in ELSS.
But is this approach really correct?
Now you may want to take lower risk (being very conservative) even though the time horizon here (30+ years) is very long and suitable for taking bigger exposure to higher risk products.
So there will always be some difference between what is right and what you are comfortable doing.
But at the end of the day, its an individual’s call.
To give some broad percentages around how much to invest where, one can follow this depending on their risk appetite:
- Highly Aggressive: 80% Equity + 20% Debt
- Aggressive: 60-70% Equity + 30-40% Debt
- Balanced: 50% Equity + 50% Debt
- Conservative: 20-40% Equity + 60-80% Debt
For record, I belong to the highly aggressive or aggressive category – for most of the times.
Now you may not want to invest so much in equity.
That is fine.
But you need to understand that for really long term investments, its better to have a higher equity component in your investments, even if you are a conservative investor (ofcourse not at the expenses of spending sleepless nights).
As for the other options within Section 80C, there is no clear-cut categorization of what is good and what isn’t. But I think that one should keep their personal finances clean and clutter-free.
That means being ruthless about not investing in unnecessary products.
Some of the products like NPS, NSC, Ulips, etc. are not suitable for most young people. Traditional life insurance plans that offer dual advantage of investments and insurance are bullshit.
If you have already taken a home loan, then the principal repayments made in the year will qualify for Section 80C benefits too. In that case, its possible that your entire exemption limit under Section 80C (of Rs 1.5 lac) is utilized by EPF, Insurance Premiums and Home Loan Principal. But that doesn’t mean that you should not be saving for your retirement goal. Ofcourse you can delay saving for your retirement and focus on clearing the loan first. But that again, is an individual’s decision about prioritizing one goal over the other. Both approaches have their merits.
As for Section 80C’s deduction limit of Rs 1.5 lac, I personally think that it is time for government to increase the limit from Rs 1.5 lac to maybe Rs 3.5 lac. For many taxpayers, this deduction is quickly exhausted. So it is time to revise it.
Or better still, link the limit to a person’s individual income. Higher the income, higher will be the limit under Section 80C.
But that is me loud thinking. I am sure my voice won’t reach the government. 😉
Coming back to young earners…
I would say that you can try out things with your money for few years and see what works and what doesn’t. It is a good and useful learning and helps in the long term.
But sooner you understand the realities of investments and the fact that tax-saving is not enough, you will be in a position to create the correct financial path for yourself. And this path can take you where you want to go – financial freedom or even becoming the richest person your family has ever had. And that is a good target. Isn’t it?
So with couple of months left to save taxes in this year, think and decide what approach you want to take.
Just do remember that tax saving alone is not enough. Those who tell you that will never be rich.
Financial goal based investment plan should always precede your tax planning. And if the investment plan is properly created, it will ensure maximum tax efficiency too.
So become a smart investor and try to find the right balance between your financial goals and tax savings. And please do not invest just to save taxes.