Tax-saving plans for long-time wealth creation

It is the tax savings season, everyone now rushes to cover the gaps as per the mandatory savings that could cushion a bit for their overall tax outflow. In this hurry, many choose investment options that would later be seen as irrelevant to their larger financial goals or could be out of sync to their risk appetite.

The best way to approach tax saving investments is to keep them in cognizance with the entire financial planning. Ideally, financial planning would encompass various facets of an individual needs and tax planning is just one such.

Of course, when looking at the various options, other than the life insurance and the Small-scale savings i.e. National Savings Scheme, we do have Public Provident Fund (PPF) and Equity Linked Savings Scheme (ELSS).

There is a lot of debate when individuals opt for either of PPF or ELSS. One is a fixed income product where the return for that year is known well in advance while the other is a market linked product where the returns are volatile.

Though, life insurance also has Unit-Linked Insurance Plans (ULIP) which have a provision to invest part or entire fund into equity I am not considering them for the discussion.

There is fan-base for both the products but these two have a different flavour altogether and could be classified as extremes of a spectrum. The PPF is a guaranteed investment avenue where the government announces the rate of return for that particular financial year.

PPF account could be opened in any of the schedule/commercial banks and post offices. The tenure of this account is limited to 15 years and could be extended in a block of five years each. The extension could be made within one year from the maturity. On completion of the period, the account is automatically matured and does not further participate as an investment.

This account could be opened by any Indian citizen on their self or on the behalf of a minor. Also, the account could be geographically transferred from one bank to another or one branch to another and one post office to a bank and/or vice versa without any additional charge.

Nomination is allowed and the account could be open with even a minimum of Rs 100 while has an upper limit of Rs 150,000 per financial year. A deposit of minimum of Rs 500 is needed to keep the account active.

ELSS is an open-ended mutual fund that has a lock-in of three years and the amount of investment is unrestricted by an individual. However, the limit to claim tax benefit under section 80(C) is limited to Rs 150,000 in a Financial Year.

The minimum lump-sum investment under this scheme is Rs 5,000 and Rs 500 if monthly with a commitment of at least 12 months. Unlike PPF, it does not require any additional investment in the subsequent years and the folio would remain active, participating in the market.

The investor has an option to continue with the investment beyond three years, though only upon death of the investor would the proceeds be given to the nominee before that. An ELSS has no restrictions for withdrawal after three years from the date of investment.

In PPF, the withdrawals are restricted. One could opt for loans on the account between third and sixth Financial Year (FY) of opening the account. But the loan must be repaid within 36 months where the interest on the loan is charged at two per cent higher than the interest prevailing that year on that account.

From the seventh FY, one can only make partial withdrawals but not opt for any loans. One could close the PPF account prematurely after the fifth FY on the grounds of medical treatment of severe or life-threatening conditions for the account holder or their family or for higher education purposes.

Though, these two products cannot be compared for their distinctive nature and investment philosophy, I would like to highlight the readers about how sticking to a consistent investment approach would yield the results and also how the power of compounding does wonders to the investor.

To illustrate this, investments in PPF and ELSS are compared over a period of 20 years considering an investment of Rs 150,000 each year at the beginning of the Financial Year.

This amount is considered as its the limit of possible tax savings for an individual tax payer. So, investing Rs 1.5 lakh each year i.e. Rs 30 lakh over 20 years returned a corpus of Rs 79.33 lakh while that of ELSS yielded Rs 2.28 crore.

Finally, there is nothing such as, best investment avenue, but it is all about opting for a best-suiting avenue. The choice of investors who are looking for a fixed and secured returns could choose to invest in PPF and enjoy the long-term returns.

In case of investors with risk appetite to digest the volatility associated with the equity markets could choose to invest in ELSS. But, a consistent contribution to save tax into these instruments would result in long-term wealth creation.

(The author is a co-founder of "Wealocity", a wealth management firm and could be reached at knk@wealocity.com)