Monday, July 21, 2008

Demystifying Section 80C – Understanding the Options

Welcome to part B of the ‘Demystifying Section 80C’ series. In part A of the series, we discussed about the significance of Section 80C. In part B today we will try understand the versatility of Section 80C and the various options under it.

While section 80C does provide numerous options to invest the one lakh, they are limited to long term investment options. This is instituted to encourage the habit of saving among tax payers.

Let’s discuss the options in brief

  1. Life Insurance Premium

Payment of premium for a life insurance policy for self or spouse or dependent kids can be included under section 80C. Have you been paying insurance premiums without utilizing the section 80C deductions? Time to start taking advantage of this provision. There’s an obvious reason why Insurance comes right on top of my list. It’s never enough stressing the importance of having life cover. More on this in the coming posts.

  1. Equity Linked Saving Schemes (Mutual Funds)

You’re young and ready to take some risk, what better than a scheme that lets you invest in the stock market and gives you tax benefits as well. Equity linked saving schemes are nothing but mutual funds that invest in the stock market and give you the tax benefit under section 80C. Not all mutual funds fall under this scheme. The special feature of the ELSS is that it has a lock in period of three years. This means that you cannot withdraw your money for at least three years. While there is a lock in period, in comparison to other instruments covered under section 80C, ELSS has the lowest lock in period. In addition, an advantage that singles out ELSS as one of the best instruments under section 80C is the fact that under current laws long term capital gains and dividends received from ELSS are tax free!!

  1. Public Provident Fund

A PPF account when opened runs for 15 years and provides a return of 8% per annum. Once opened investors must make contributions every year to keep their PPF accounts active. The minimum amount is Rs. 500 and the maximum is Rs. 70,000. Currently the income (interest) earned on a PPF account is tax free which makes it all the more attractive as an investment option.

Example: If you were to invest Rs. 10,000 every year in a PPF account, you would be investing Rs. 150,000 over a period of 15 years and the future value (Rs. 293,243) of this amount after 15 years at 8% interest is almost double of the present value.

Important note: The deduction made by your company towards ‘Provident Fund’ contribution can also be considered under section 80C.

  1. Term Deposits

A Bank Term Deposit is similar to a fixed deposit except that it has a lock in period of five years. A bank term deposit cannot be encashed before the expiry of five years from the date of the deposit. Do note that while the lock in period is lesser than PPF or NSC, the interest earned is taxable unlike PPF or ELSS.

Let’s take an example:

Total Taxable Income - Rs. 300,000

Income tax without section 80C - Rs. 15,000


Investments under 80C

PF Contribution - Rs. 21,600

Public Provident fund Contribution - Rs. 12,000

(At Rs. 1000 per month)

So far your total exemption under section 80C is Rs. 33,600. To take advantage of the maximum tax exemption available under section 80C you need to make investments of Rs. 66,400 more. If you decide to invest in ELSS using a SIP of Rs. 5600 per month, then

ELSS - Rs. 67,200

(SIP of Rs. 5600 per month)

Total investments - Rs. 100,800

Amount considered under - Rs. 100,000

Section 80C

Income tax with section 80C - Rs. 8,000


While this might seem like a lot of hard work, remember that not only are you saving money in this process you are also forcing yourself to invest!

While there are other options such as National Savings Certificates, Pension Plans, Infrastructure Bonds, payment towards principal repayment in housing loans, etc. in my opinion the four listed above are the most attractive ones. They cater to both a risk-averse as well as a risk-taking investor.

With this we conclude the series on section 80C. Watch this space for more interesting articles in personal finance and how you can make your money work for you.

Thursday, July 17, 2008

Demystifying Section 80C – An Introduction

To the uninitiated, Section 80C is that provision in the Indian Income Tax laws that allows you to make specific investments and exempts that amount from being included in your total taxable income.

Didn't get that?

'Save a part of your income and the taxman won't tax that money.'

'What do you mean he won't tax?'

'I mean he won't tax.'

'Oh, another scam!! My mom already warned me.'

'No it's not another scam! It's there in the Indian Tax Laws! It's that piece of paper/ email your payroll/ HR department sends you at the beginning of every financial year!'

'What mail? The one that asks if I have insurance, mutual funds, deposits, etc… Oh, I was wondering why they want my personal investment details.'

Still in the process of figuring out Section 80C? Welcome to the 'Demystifying Section 80C' series and let's do it together.

Introduction of Section 80C

Indian Tax laws have always provided simple tax saving investment options. But it would be limited to specific amounts in certain instruments. With the introduction of Section 80C, the Indian tax payer now has the freedom to choose the instruments and the proportions.

Section 80C Limits

Yes, of course there's a limit. The government needs to run the country, remember! The individual tax payer can now invest rupees one lakh in the instruments specified in Section 80C in any proportion that he wishes.

Would you like to see how much difference rupees one lakh could make to your taxable income and eventually your tax?

With appropriate investments made as specified in Section 80C.

  • If you are a male tax payer earning up to Rs. 250,000 you do not have to pay any taxes
  • If you are a female tax payer earning up to Rs. 285,000 you do not have to pay any taxes

Even if you are above those limits, the savings from utilizing the provisions of Section 80C should not escape you. Section C provides one of those exceptional opportunities to have your cake and eat it too!! You get to save for the future and you get to save income tax!!

In part two of this series, we will discuss the versatility of Section 80C and the variable investment options available.

Saturday, July 12, 2008

Emergency Fund - A Burning Need

A few weeks back I mentioned that if you are among those people who have absolutely no clue what to do with your money, then a FA is really the best place to start. I stand corrected. A Financial Advisor would be the second best place to start. The first is an Emergency Fund.

The 'What'
Let's start with what is not an emergency fund. It's not some extra stashed awa
y money to be used to pay off your credit card bill or to be used to manage extra expenses during the month or buy a car or a new gadget or throw a party or to buy that Gucci bag! An emergency fund is to be used only in the case of an emergency - an emergency that threatens survival. It could be anything - loss of a job, accident, death, a loved one's emergency. In a culture like ours, we constantly depend on the cushion provided by the immediate family in case of emergencies. But haven't we heard of stories where families being hit by unexpected disasters have struggled to get up and start again. And what if the emergency was a threat to your immediate family and you were to provide that cushion? It's not that an emergency fund will provide solutions to the disaster but it will certainly help you manage your emergency better than if you didn't have the emergency fund.

The 'How Much'

There is no fixed thumb rule on how much is required or sufficient. While a number of books and websites suggest a back up of four months salary, an emergency fund should typically sustain you for at least six months. In the event of an emergency this money should provide for your basic living expenditure, continue paying off your EMIs, insurance premiums and take care of basic medical expenses that may pop up. How much is sufficient also depends on the number of dependents on the money. If you are married then your emergency money should cover expenses for at least six months for your spouse and you. If you have kids then include their expenses too. If you live with your parents/ relatives who depend on your income then don't forget to add them too.

The 'Where' Building an emergency fund may seem like an added burden in the beginning. The truth is that, it will bail you out of the real burden that awaits around the corner. If your budget is too tight to warrant any additional savings, then all the more reason to start an emergency fund. When you can't manage on a bright sunny day, it's going to be impossible on a rainy day. Consciously reduce expenses and set aside a certain amount of money (you can start with as low as Rs. 1000) to build your emergency fund. You can start by simply opening a savings account separate from your primary account.

When I tried to open an additional account with ICICI bank, I realized that the minimum quarterly balance to be maintained is Rs. 10,000. Now if you have even three such accounts this would mean that Rs. 30,000 would be blocked unnecessarily until you close the accounts. A way out of this is to open an account in a public sector bank like SBI where the minimum balance is Rs. 500 for a non-cheque operated account. Make this money as inaccessible as possible, so that you are tempted to use it only in the event of a dire emergency.

Another option that I personally find useful is Recurring Deposits. A recurring deposit will debit your account of a specified amount every month. Once you have built enough using a recurring deposit, move the money to another account or covert it to a medium term fixed deposit. If your bank (like mine) does not offer Recurring Deposits, then go for the option of a simple Fixed Deposit. Most banks these days allow customers to top up their fixed deposits by a minimum amount as and when required. When you've made up your mind to adopt the discipline of saving there will be no shortage in the number of ways you can do it. I know a few people who simply keep their emergency fund in an envelope in a safe and not so easily accessible place.

There are millions of articles on the internet and personal finance books that talk about emergency funds. The common thread that links them all is the stress on starting today and right away.

Friday, July 4, 2008

Got a raise? Don't go shopping now!

It's the first week of July and a number of you must already be armed with your increment letters. While some of you must be delighted, some disappointed and the others neutral, the fact is you've come to posses some extra cash and if you don't act fast this extra money is going to seep into your daily expenses and lose its way. If you want to get the best out of your pay raise, you need to plan and plan right away.

The first thing NOT to do is splurge that extra amount. Even before that amount reaches your salary account by the end of this month, plan in advance what you want to do with the money. Stop thinking of your pay increase as a way to up your lifestyle. Instead of increasing your spending habits, increase your saving habits. This means no new gadgets, new clothes, branded stuff, or visits to an expensive restaurant, etc. with the money. The trick is to continue living like you never got the raise.

When you keep seeing people around you indulging in luxuries and when your credit card bill is bursting at the seams, it may seem easier said than done to pretend like you never got the raise. If it does get difficult, allocate a much smaller percentage (say 10% of the increment) for your expenses, earmark the rest for savings. This way you can pretend like you got a much smaller increment than it actually is.

Decide on where you want to utilize this extra money. There are a number of options depending on your requirements.

1. If you have an outstanding loan (educational loan, car loan, home loan, money borrowed from parents, friends, etc), you could use this extra amount to increase your EMI on the loan. Ensure that this amount is allocated for paying off your debt right at the beginning of the month before you get tempted to start spending it either by setting up an automatic transfer or manually setting aside those funds in a different account.

2. Use this money to set up an emergency fund (if you don't have one already). A salaried person must have an emergency fund equal to at least four months of the individual's monthly compensation. Now that your monthly compensation has increased, so should your emergency fund. Remember that an emergency fund is for a raining day and not to pay your irresponsible over the limit credit card bill. Stash away a portion of your income every month to set up this emergency fund. The best place to store your emergency fund is a savings account. But make sure that this is not the same account as your primary account.

3. Year after year we keep seeing people who declare that they will save the maximum tax exempted amount to their finance departments. Come March and when this hasn't happened they end up paying a lump sum in taxes. Set aside your increment for this very saving.
  • Set up a SIP for an tax saving ELSS fund
  • Use the amount to pay up for your insurance premium
  • Use the amount to buy tax saving deposits
This way you've saved and you don't have to scramble during the last minute to save your hard-earned money from being eaten up by income tax.

4. Set up a Systematic Investment Plan to invest in a mutual fund or index fund. If you already have SIPs running, use the money to top up your investments or delve into a new fund. Remember to do your research before investing.

And about me... I plan to set aside a part of my raise for an emergency fund and a part of it for an ELSS fund