Want to save tax? Get clued in on liquidity, returns

Not sure which debt instrument to save tax with? Read on.
It might seem like you are spoilt for choice, but choosing the best one is far from easy. In the ultimate analysis, it all boils down to striking a fine balance between liquidity and returns that a tool has to offer.

When it comes to returns, the Public Provident Fund (PPF) leads the race. One can gain a tax-free return of 8.6% as well as a tax exemption on investments up to `1 lakh under section 80C. But the dampener is its 15-year tenure which means it is not a very liquid instrument. There is partial liquidity in the second financial year after the year of investment. For example, if you invest in this financial year, that is FY12, you can avail of a loan in FY14. Also, you can withdraw up to 50% of the balance of the fourth year from the sixth year onwards.

Amar Pandit, chief executive officer at myfinancialadvisor.com, advises investors to make full use of the PPF, as by far it yields the highest post tax returns. “Even if the tenure of the PPF is as long as 15 years, it still makes for a very good investment as a tax saving option. The tenure one needs to wait for is a small price to pay for a better post-tax yield with the power of compounding,” he said.

Most other instruments offer somewhat a similar amount of liquidity, thus making returns the crucial deciding factor. The recently-launched National Highways Authority of India’s non-convertible bonds are a case in point, which offer up to 8.2% and 8.3% for 10 years and 15 years, respectively. What works for these bonds is the fact that the interest received on this instrument comes without any tax component.  The bonds are going to be traded in the secondary market immediately. Since the bonds are floated by a state-run company, experts consider it to be a good tax saving option as it is the only product offering tax-free returns.

“It is a very attractive product, but since `50,000 is the minimum investible amount needed, only a few investors may take exposure to the same. The interest earned is tax free; had it been a taxable bond, it would have given a pre-tax return of close to 12%. One should invest here after having exhausted all other options. The bonds have come in at the right time as interest rates have peaked out too and people should clearly take advantage of this situation,” said Jayant R Pai, vice-president of Parag Parikh Financial Advisory Services.

A bank fixed deposit sizes up well as it offers the next best rates post taxation, at 6.3%. There is a lock-in of five years, though. Don’t expect too much from instruments like the National Savings Certificate where returns come in at 5.88% for a 5-year term and 6.09% for 10 years.

This is not the best in terms of returns, said Suresh Sadagopan, principal financial planner at Ladder7 Financial Advisories. “The NSC is not very alluring as an investment destination today as it offers poor post-tax returns, given that pre-tax returns are 8.4% and 8.7% for 5- & 10-year tenures,” he said.

If you are employed, the Employee Provident Fund (EPF) fits in with returns of 6.02%, with a 5-year lock-in. Salaried individuals are compulsorily required to contribute 12% of the sum of basic pay and dearness allowance towards the EPF. The sum is deducted by employers from the monthly payroll of employees as a social security scheme, which is akin to forced saving towards retirement planning. The EPF brings with it key benefits as a fixed-income instrument, providing tax gains under Section 80C at the time of investment. Even the returns from the EPF are tax free on maturity. The employer also has to make a matching contribution to the EPF.

For time deposits, which are another form of fixed deposits at post offices, returns work out to 5.81% after taxes. Though there is a provision of premature withdrawal here, it comes at reduced rates of interest.

In this scenario, infrastructure bonds are worth a try, which can offer higher returns than many of the instruments listed above.

However, it serves up well after exhausting the Rs1 lakh limit.
Over and above the Rs1 lakh tax exemption provided by the five instruments above, the infrastructure bond offers additional tax savings of `20,000 under section 80CCF. Four infra bonds have hit
the market so far, with returns ranging from 8.5-9.16%.  One would have to remain invested for a minimum of 5 years in all of these bonds.

The big plus of infrastructure bonds is that it would give you the opportunity to save an additional `20,000 in taxable income. Experts suggest investing in it only after exhausting the `1 lakh limit through tax saving instruments which come under section 80C.

The additional savings can actually enhance the yield on these funds, said Paul DSouza, who runs Cuzzins Investment Services.

“The investor is actually putting in less than Rs20,000 if one subtracts the amount which would otherwise have gone as taxes. This gives you an effective higher yield, which for people in the highest tax slabs, can exceed 14%,” he said.