How to Select the Best Suitable Tax-saving Option for You

As we approach the end of the current financial year, it is imperative to save taxes by investing wisely. However, many salaried individuals put off this task until the last minute, resulting in costly financial mistakes. Choosing tax-saving investments that match your risk tolerance is a considerably more meaningful activity than haphazard investing. If properly managed, a considerable sum of money can be saved through the numerous routes available for income tax savings.

Tax-saving investments are an essential component of any financial portfolio since they provide tax benefits under Section 80C and other relevant sections of the Income-tax Act of 1961. If you intend to make tax-saving investments now, it is critical that you understand the various tax-saving avenues. Section 80C of the Income-tax Act of 1961 provides a number of tax-saving investment vehicles. But not all of these are appropriate for everyone; consider investing based on your risk tolerance, investment horizon, and financial objectives. As a wise investor, you should seek tax-saving investments that not only provide tax exemption but also allow you to make tax-free income.

Are you among the procrastinators with a last-minute syndrome, the ones who have not completed their tax planning for the FY 2022-23 yet?

Well, if you are also trying to figure out where to invest, your search ends here. In this article, we discuss the best tax-saving investment options that can reduce your tax outgo. It cuts through the clutter and tells you which is the most suitable option for you. We evaluated 8 tax-saving solutions based on a few essential parameters: Returns, safety, flexibility, liquidity, costs, transparency, ease of investment and taxability of income.

Having said that, before you go ahead and invest in a host of tax-saving investment avenues, it would be wise to assess whether you are a risk-taker (aggressive) or risk-averse (conservative). By doing this, you'll be able to compliment tax-saving with investment planning and choose investment instruments in comparison to your risk appetite.

If you are willing to face risks, you should concentrate on selecting instruments that provide market-linked returns. The market-linked schemes under Section 80C are mutual funds' Equity Linked Savings Schemes (ELSS) and Unit Linked Insurance Plans (ULIPs). These plans make investments in financial market securities such as stocks. Their gains are related to market returns and are vulnerable to market risks. These investments offer no assurance of capital safety.

In case if you are a risk-averse investor (conservative), who would like to earn assured returns, then you should ideally stay away from the ones providing market-linked or variable returns. You may consider the tax-saving instruments as listed below:

1. Bank Fixed Deposits

You can save tax by investing in Tax Saver Fixed Deposits, which can fetch you tax deductions under Section 80C of the Indian Income-tax Act, 1961. You can claim a deduction of a maximum of Rs 1.5 lacs. There is a lock-in period of 5 years for such FDs; this lock-in, in a way, is good for compounding wealth safely and steadily. The interest earned on FDs is taxable as per the investor's income tax slab rate.

However, it should be kept in mind that any premature withdrawals made may nullify any tax benefit on such investments. To invest, you have 3 options: Reinvestment Deposit, Quarterly Interest Payout or Monthly Interest Payout. You can choose the one most suitable for you as per your cash flow needs.

The deposits can be held in a single name or jointly (by two adults or by an adult and a minor), but in the case of joint holdings, the Section 80C deduction benefit is available only to the first holder, who should be a PAN (Permanent Account Number) holder. Any Indian resident can open a tax-saving FD and avail of its benefits. The minimum investment amount for most banks is Rs 1,000/-; however, it may vary from bank to bank.

2. Public Provident Fund (PPF)

Public Provident Scheme is a popular investment vehicle for saving tax, and one of the major reasons why PPF is still a preferred investment option is because of its secure nature. For a long-term savings cum investment product, you need to open a PPF account at the post office or designated branches of public and private sector banks to start with. Contributions to the PPF account earn a guaranteed rate of interest. You can claim deductions under Section 80C up to Rs 1.5 lacs in a financial year on these deposits.

One thing to keep in mind before investing in PPF is the lock-in period, which is 15 years; there are provisions under which investors can partially withdraw funds after completing 7 years. In a financial year, an individual can make only one withdrawal. PPF account holders can avail of EEE (Exempt, Exempt, Exempt) tax benefit, which means that investments made up to Rs 1.5 lakh in a year, the returns you earn from PPF, and the corpus when the investment is mature, are all exempted from taxation.

The current interest rate of PPF is 7.10%. One of the biggest benefits of investing in PPF is that the risk associated is very low. PPF incorporates the feature of tax-saving investments in order to help investors to create a financial cushion post-retirement. The interest rate on the PPF balance is reset every quarter. The minimum that can be invested in PPF is Rs 500, while the maximum is Rs 1.50 lakh in a financial year. You have a choice to invest in a lumpsum or in 12 instalments.

[Read: Interest Rates for Small Savings Schemes Hiked Again! Here's All You Need to Know]

3. National Savings Certificate (NSC)

National Savings Certificates are a savings bond scheme which encourages primarily small to mid-income investors to invest while saving on income tax under Section 80C. If you have a Savings account with a Bank or a Post Office, you can buy NSC certificates in e-mode, provided you have access to internet banking. NSCs can be bought by an investor for self or on behalf of a minor, or with another adult as a joint account.

Investors can claim up to Rs 1.5 lacs as a tax deduction under Section 80C. And the interest earned from NSC is added back to the original investment amount and is eligible for tax exemption. Upon maturity of the NSC scheme, the investor will receive the entire maturity amount. Since no TDS is deducted on maturity payouts, the investors are required to pay themselves the applicable tax on such proceeds. NSC has a 5-year tenure, and the minimum investment required is Rs 100 (and in multiples of Rs 100), while there isn't an upper limit.

4. Senior Citizens Savings Scheme (SCSS)

Senior Citizen Savings Scheme (SCSS) is a government-backed savings instrument for individuals above the age of 60 which gives a steady and secure source of income for their post-retirement phase and offers comparatively substantial returns. The scheme comes with a period of five years, and the interest income is payable on a quarterly basis. As compared to the other tax-saving investments, the senior citizen saving scheme offers the highest interest rate of 7.4% per annum and ensures a guaranteed return to investors.

Under this scheme, individuals are allowed to make a one-time investment minimum of Rs 1,000 and can invest up to Rs 15 lakhs. The principal amount deposited in an SCSS account is eligible for tax deductions under Section 80C of the Income-tax Act, 1961, up to the limit of Rs 1.5 lacs. However, this exemption is applicable only under the existing tax regime. It is not allowed if an individual chooses to file tax returns under the new system introduced in Union Budget 2020. The interest received is, however, subject to taxation as per the applicable slab of the concerned taxpayer.

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5. Sukanya Samriddhi Yojana (SSY)

Another tax-saving investment option is Sukanya Samriddhi Yojana which is a small deposit scheme which is particularly designed for a girl child. The plan is introduced as a part of 'Beti Bachao Beti Padhao' campaign of the government. The plan currently provides an interest rate of 7.6% ad also offers tax exemption.

The parent or guardian can open the SSY Account any time between the birth of a girl child and the time she attains 10 years of age. The investment made under this scheme is eligible for tax exemption up to a maximum of Rs 1.5 lakh under Section 80C of the Income-tax Act, 1961. The accrued interest earned from the SSY scheme is compounded annually and is also eligible for tax exemption, and the maturity amount is also exempted from tax. As a tax-saving investment option, the plan ensures the safety of investment and secures the future of the girl child.

For risk-takers, here is the list of market-linked tax-saving investment instruments that offer a deduction up to a maximum of Rs 1.50 lac per annum under Section 80C.

6. National Pension Scheme (NPS)

The NPS, or the New Pension Scheme, is regulated by the Pension Funds Regulatory and Development Authority - PFRDA. Any citizen of India over the 18 - 60 years age bracket can participate in it. It is extremely cost-effective since fund management charges are low.

The fund managers manage the money in three separate accounts having distinct asset profiles, viz. Equity, Corporate bonds and Government securities. Investors can choose to manage their portfolio actively (active choice) or passively (auto choice).

Contributions made to the NPS are covered under Section 80CCD of the Income-tax Act. The aggregate limit of deduction under this section, along with Sections 80C and 80CCC, cannot exceed Rs 1.5 lacs. You can also avail of an additional tax benefit on investments of Rs 50,000 under Section 80CCD(1B). Given the range of options, NPS is particularly useful for individuals with varying risk appetites looking to set aside money towards retirement. With the combination of equity and bond, one can gain good returns on investment over a long-term period.

7. Equity Linked Savings Scheme (ELSS)

Equity Linked Savings Scheme or (ELSS) is a diversified equity mutual fund providing tax saving benefits. Hence, ELSS is also popularly known as a Tax-saving Fund. However, the returns are not fixed in an equity-linked saving scheme and vary according to the market performance of the fund.

If you want to invest in mutual funds and want to save income tax, then ELSS should be your go-to option. ELSS is a diversified equity mutual fund investment option that invests in the capital market and chooses stocks with different market capitalisations. ELSS investors can claim benefits under Section 80C of the Income-tax Act, 1961, and get tax deductions maximum of Rs 1.5 lacs in a financial year.

When it comes to equity schemes, there are certain risks involved. Investing in ELSS can be risky, and returns can be volatile in the short term. This tax-saving investment option offers liquidity and flexibility and is best suitable for those who have a high-risk appetite. It is important to note that ELSS comes with the least lock-in period, i.e., 3 years. Moreover, returns on ELSS schemes are taxed at 10% with no indexation benefit under the LTCG head if profits exceed Rs. 1 lac in a given financial year.

8. Unit-Linked Insurance Plan (ULIP)

ULIP is a specially designed investment-cum-insurance product where a part of your investment goes towards life insurance premium while the remaining is invested in the investment fund of your choice - it can be equity, debt, or a mix of both. ULIP can help you save tax under Section 80C. Moreover, when the policy matures, the returns are exempted from income tax under Section 10(10D) of the Income-tax Act, 1961. The best part about ULIPs is that you can switch between funds as per your investment objective during the term of the plan.

Unlike NPS, the rate of return in ULIPs is not fixed because the funds are invested in the combination of equity, debt, and hybrid funds, as per the choice of an individual investor. The premium you pay, after accounting for allocation and other charges, is invested in equity and/or debt securities. All you have to do is, select the investment plan/allocation option as provided by the Unit-linked Insurance Plan (ULIP). Generally, fund options are classified as 'aggressive' (which invests in equity), 'moderate or balanced' (which invests in debt as well as equity), and 'conservative' (which invests purely in debt instruments).

ULIPs have a minimum 5-year lock-in period and have a minimum premium paying term. Even though ULIP is a lucrative option for tax-saving investment, the returns on ULIPs entirely depend on the market performance of the fund.

To conclude...

Rather than waiting for the end of the financial year and opting for ad-hoc tax-saving instruments, it would be a smarter approach to begin investments in the early quarters of the financial year so that you can get time to plan your investments wisely aligned to your financial goals and avail maximum tax benefits.

PS: Tax saving is an integral part of one's wealth creation journey. Equity-Linked Saving Scheme (ELSS), also known as Tax Saving Mutual Fund, is one of the most worthy avenues for tax saving. PersonalFN's Definitive Guide, '3 Best ELSS to Invest in 2023', offers a list of carefully selected ELSS funds to invest in 2023.

This Guide will show you how to pick a worthy ELSS, a tax-saving mutual fund, that could potentially maximise your wealth and act as an effective tool for tax planning. If you are looking to invest in ELSS funds, then Subscribe now! To PersonalFN's Definitive Guide '3 Best ELSS to Invest in 2023'.

MITALI DHOKE is a Research Analyst at PersonalFN. She is an MBA (Finance) and a post-graduate in commerce (M. Com). She focuses primarily on covering articles around mutual funds including NFOs, financial planning and fixed-income products. Mitali holds an overall experience of 4 years in the financial services industry.

She also actively contributes towards content creation for PersonalFN’s social media platforms in the endeavour to educate investors and enhance their financial knowledge.