New vs old tax regime
If you are a salaried individual and have no business income, you are required to make this choice every year as per income tax laws.
The new tax regime offers the taxpayer lower tax rates and more tax slabs but with no deductions or exemptions. The old tax regime, on the other hand, offers a host of deductions and exemptions to reduce one’s tax liability. These deductions/exemptions are allowed on the basis of specified investments such as investments in ELSS, PPF, NPS etc. under section 80C; other tax deductions like standard deduction and interest on home loan for self-occupied House property etc.; and exemptions on certain expenses like house rent allowance (HRA) and leave travel allowance (LTA).
Many taxpayers are shifting to the new tax regime because of lock-ins under section 80C investments. These include a three-year lock-in for investments in ELSS and withdrawal of one’s EPF and VPF contributions after retirement. However, one should consider returns on these investments (especially those that are exempt under the Income-tax Act, 1961) and allocation of funds as per financial goals such as buying house, retirement, kids’ education etc, before selecting the tax regime you want to opt for.
Broadly speaking, if you have no financial constraints and are ready to lock the funds in specific investments for specified period, then tax liability under the old regime will be lower than the new regime. However, if you want to avoid locking in the funds, new regime will be more tax beneficial.
Ways to save tax under old regime
Salaried employees need to plan their cash flows on the basis of monthly income, tax out-go per month (TDS on salary), expenses and investment pattern. Fixed income investments, i.e., savings for long-term (child education and marriage) along with retirement planning is most important and one needs to accordingly invest and choose tax-saving instruments. Key parameters for deciding on investments will be risk-return trade-off, lock-in period, flexibility and transparency.
To avail benefits of deduction under section 80C, one needs to adhere to lock-in period and decide on asset allocation accordingly. For high-risk investments, invest for long term to minimise risk and maximise returns. Pros and cons of some of the popular investments are discussed below:
- ELSS: Equity Linked Saving Scheme (ELSS) funds are capable of giving high returns and have the shortest lock-in of 3 years. However, the return is subject to market risk and one should invest basis their own risk appetite. Further, in order to get the best results from the said scheme you have to stay invested for the long term and opt for the SIP route instead of investing as lump-sum.
- ULIP: Unit Linked Insurance Plans (ULIPs) offered by insurance companies come with tax benefit under section 80C and also tax-free return under section 10(10(d)) subject to certain terms and conditions. These plans have minimum lock-in period of 5 years and early withdrawals will attract surrender charges. Current ULIP plans offer a host of benefits like flexibility of switching between funds, low expenses, death benefit and professional fund management.
- Traditional Life Insurance Plans: This is one of the most common tax-saving instruments among salaried employees. These plans offer tax benefits and should be chosen in consultation with a qualified insurance professional. Risk in these plans is the lowest and a life insurance policy will give financial protection to your loved ones in your absence. Do note that they offer the lowest returns in the investment basket of section 80C.
- PPF: The PPF is one of the most popular choices when it comes to investment as it offers tax-free fixed guaranteed returns and the highest safety of funds. PPF offers flexibility of partial withdrawals after 7 years of term as per conditions but has lock-in of 15 years for full withdrawal. Investment in PPF can be used for child’s education and marriage as a lump sum amount can be withdrawn on maturity without any tax liability.
- NPS: An additional deduction for investment up to R. 50,000 in NPS (Tier I account) is available exclusively to NPS subscribers under subsection 80CCD (1B). This is over and above the deduction of Rs. 1.5 lakh available under section 80C of the Income-tax Act. NPS can help you generate pension in your golden years.
- Tax Saving FDs: Investment in FD with a lock-in of 5 years qualify for tax deduction under section 80C.This is not a very attractive option as returns are low currently and interest earned on these FDs is also taxable. However, senior citizens can claim deduction under section 80TTB on the interest earned.
- Health Insurance: Health insurance is a must not only from the purpose of tax-saving but it should also be an essential part of your financial planning. Health insurance taxation benefits are available for premiums paid for self, family and dependent parents.
One should note that investments in avenues like ELSS, PPF etc. should not be restricted to Rs 1.5 lakh, i.e., tax-saving benefit under section 80C. The above-recommended investments, health and life insurance covers should form a part of your comprehensive financial planning. Review your investment pattern regularly and make necessary changes in the investment pattern basis risk profiling and fund requirement.
(The writer is Founder & Managing Director, MyMoneyMantra.in – A financial advisory firm)