TAX PLANNING: A Cut Above The Rest

K AR AN SEHGAL ET INTELLIGENCE GROU P

IN THE other articles of this supplement, ET Intelligence Group attempted to find out the optimum way of tax planning. In all walks of life, there is always a gap between the cup and the lips. And the same applies to tax planning as well. In theory, there are dozens of ways to save tax and maximise your posttax income. However, in practice, all avenues do not work for everybody.
    We decided to gauge the gap between the theory and practice by doing a small survey. We sent a questionnaire to people asking them how they invest Rs 100,000 —the exemption limit allowed under Section 80C of Income Tax Act. We wanted to gauge the relative popularity of the public provident fund (PPF) schemes, mutual funds (MF), life insurance, unit-linked insurance plans (Ulips), education and housing loans among, others. And, we must say, we were quite surprised by the outcome. PPF, continues a popular tax saving instrument. In fact, three instruments — PPF, MFs and life insurance — account for almost 90% of the investments falling under the Section 80C.
    Most of the people, who responded, were less than 30-year-old. It turned out that almost everyone has taken insurance cover and premium paid accounts for a quarter of the exemption limit. Well, there is a positive side to it. For the same sum assured, a 25-year-old pays much lesser premium than say a 35-year-old. So, it makes sense to buy an insurance cover at a younger age, preferably as soon as you get a job!
    A few people have also invested in Ulips for tax saving purposes. Ulips are actually a combination of MFs and life insurance. The premium on a Ulip policy tends to be much higher than a simple term insurance for the same sum assured. So, go for a plain vanilla insurance and invest the difference in the premium in equity markets. This way, you enhance your return as Ulips have an entry load, where up to 40% of the firstyear premium goes as policy expense and is not invested.
    Interestingly, people have invested as much as 50-70% of the Rs 1-lakh exemption limit in PPF schemes. It entirely depends upon the risk appetite of the individual as to how much he/she wants to invest in a PPF scheme. But, there is a great merit in PPF schemes, which eludes even those, who invest in them. Not only the principal amount but the interest an individual gets on initial investment is also tax-free. So, even
though PPF pays 8% interest, post-tax return turn-out to be much higher. Given last year's mayhem in financial markets, it makes a lot of sense to invest a significant portion of the exemption limit in PPF schemes.
    As per the survey, on an average, around 25%-40% of the exemption limit is invested in Equity Linked Savings Schemes (ELSS) offered by various mutual funds. In long term, equity has proven to beat all asset classes and ELSS is the best way to capture this growth while minimising tax outgo. Equity investment are however fraught with risks as it happened in 2008, when stock market more than halved and all MF schemes ended with negative returns. However, on a long-term basis, if a certain amount is invested in equities every year, it effectively becomes a systematic investment plan (SIP), where in price of buying a share gets averaged out due to investment at regular intervals.
    A very small percentage of respondents had put all their money in either Ulip or equity linked savings scheme (ELSS). Such respondents turn out to be very young and early in their careers. Their rationale is that as they can afford to lose money, they had taken this risk to maximise return over long term. While it may sound trivial to many, equity works for only those risking to lose in the short run.
    The point of the survey is not to suggest an efficient portfolio. However, it does indicate that PPF schemes continue to be hit among urban Indian middle class while , even as equity and insurance continues to make inroads.
    karan.sehgal@timesgroup.com