In a country of 1.5 billion people, only 5% of people pay income tax!
It hurts when you are required to pay taxes on your hard-earned income, especially on investments with a view toward wealth creation. So, what tax-free investment options does one have in India?
Understanding the applicability of taxes at various stages of wealth augmentation can help save your hard-earned money from going to Income Tax Department coffers.
Firstly, every investment corpus comes from a legitimate business transaction (for business owners) or salary paid for services (service class investors) and becomes taxable at the point of inception above a certain slab. This is the first stage of taxation and is tackled by using strategies that reduce taxable income. These include investing in instruments that are given exemption under section 80C. Though these do not qualify as tax-free investments, they certainly help save tax on your earnings.
After successfully confronting the first tax stage of your investment journey, you now have surplus funds which you want to put to work for wealth creation. Now you will be accosted by the second dilemma – tax on the returns your investment is giving you!
No matter how well your returns outperform the average market returns, the IT guys are there to play the equalizer role and erode more than a third of this earning. Hence, this is the stage where one should look for options that give tax-free returns while outperforming the average market returns. In the traditional scenario, the Government PPF is the best tax-free option at this stage of investment. It is the safest and most highly recommended route by classical financial advisors. And why not?
- One of the goals of PPF is to yield more interest than what banks offer. Hence, the annual returns will generally be higher than comparable investment instruments.
- It provides income tax exemptions on the amount invested. So, it beautifully tackles the first dilemma (mentioned earlier)- earnings taxable at the point of inception and reduced by 80C investment route.
- Most significantly, the interest, our primary concern at this stage, is tax-free.
Now hold your thoughts here! Don’t get swayed by half the story. There’s more than that catches the eye!
- The maximum amount that can be invested in this scheme is limited to Rs 1.5 lac per annum by the Government. If you want to invest anything above this amount, you got to look elsewhere!
- Interest you earn is dependent on Government decision, hence, not entirely free from volatility, albeit, mostly stable.
So, what does one do if one is still left with a considerable corpus to invest after stage one and investment in PPF?
Well, here’s where the newer technological advances in the Fintech and Insutech open up a unique, lucrative and, above all, tax-free investment option – Investment in pre-owned policies.
Yes, you read that right- tax-free!
What does this investment exactly mean?
An investment in a pre-owned policy means that you are buying a delinquent life insurance policy i.e. the owner is unable to or does not intend to carry on paying its premiums.
So, at this stage where you are looking for a high-return investment that is not taxable, this qualifies as an excellent alternative. Why?
- You are generating wealth with a potential of 8-12% returns per annum
- They are as safe as FDs while being completely tax-free.
- And don’t worry! The pre-owned investment policies transfer all the policy rights to the new policyholder.
- There is no limit to how much you can invest
- Above all, the investment horizon can be anywhere between 3-12 years as per your requirement, as against the PPF option that is missing this flexibility.
Now let’s move on to the third stage of your investment journey. This is where your investments have matured, and you wish to capitalize on them for your personal needs or reinvestment. Here again, the taxman comes knocking at your door, and you need to part with a minimum of one-third of the maturity amount! If you had invested in a tax-exempt instrument at maturity, you would have boosted your wealth by at least 30% at this point. Here too, both our favourites, PPF and Pre-owned policies, stand out as the best tax-free investment options, with the latter giving you a better return in a shorter duration, since the PPF amount can only be withdrawn in entirety after 15 years lock-in period.
Apart from these, some other tax-free investment opportunities in the market can work out for various investment stages, but one needs to consider all pros and cons before falling for one. For instance, Mutual funds under the Equity Linked Savings Scheme (ELSS) are excellent options for younger investors due to their higher risk tolerance as these investments experience market-linked fluctuations. However, only the growth pay-out options are tax-free but it has 10% Capital Gains tax on maturity. So this option certainly fails our stage 3 criteria. Then there are the National Savings Certificates (NSC) which again do not qualify the stage three i.e. maturity criteria. Finally, FDs, the classical investments considered the safest asset class, do not stand up to any of the three stages of investment, barring the 5-year lock-in.
In a nutshell, very few investment alternatives maximize returns by saving on taxes at “all” stages of an investment journey, and the novel asset class of pre-owned policy, happens to be the one that stands ground at every stage of this exciting expedition.
It’s like purchasing a pre-owned car with a difference that it has extra power to give a better mileage which is, evidently, not true in the context of pre-owned vehicles!
For more information on how to save taxes at all three phases of your investment journey, contact ThePolicyExchange here.
