A salary hike in your early professional years helps you upgrade your lifestyle. You must put this extra money to use by picking tax-saving investments based on your risk profile. It helps one earn inflation-beating returns and achieve vital financial goals. If the salary hike has put you in the taxable bracket, choose investments that qualify for the Section 80C tax deduction.
Conservative investors can invest in the government-backed Public Provident Fund (PPF) or the National Savings Certificate (NSC). It offers a higher interest rate than bank fixed deposits and is more tax-efficient. Moreover, both these investments qualify for the Section 80C tax deduction up to ₹1.5 Lakh per annum.
PPF currently offers an interest rate of 7.1% for the April to June 2022 quarter and NSC an interest rate of 6.8%. Moreover, PPF qualifies for the EEE (exempt-exempt-exempt) income tax regime. Investment up to ₹1.5 Lakh per annum qualifies for the Section 80C tax deduction. Moreover, PPF interest and withdrawals at maturity are tax-free.
NSC has a five-year maturity period and the interest is reinvested and not paid out to investors. The NSC interest for the first four years of the investment is reinvested and qualifies for the Section 80C tax deduction. However, the NSC interest at maturity is taxed based on your income tax slab.
Aggressive investors can look at Equity Linked Savings Schemes or ELSS, which invests at least 80% of its assets in equity and equity-linked instruments. ELSS qualifies for the Section 80C tax deduction and has the shortest lock-in period of three years among Section 80C tax-saving investments. One must invest in ELSS through the systematic investment plan or SIP. It is a facility offered by Asset Management Companies (AMCs) where you can invest specific amounts regularly in mutual fund schemes. One can average the unit’s purchase price over time, called Rupee Cost Averaging, and avoid timing the stock market.
ELSS is a tax-efficient investment if one falls in the higher income tax brackets. For instance, long-term capital gains or LTCG from ELSS up to ₹1 Lakh are tax-free. However, LTCG above ₹1 Lakh is taxed at 10% without the indexation benefit.
If you have exhausted the Section 80C tax limit, you can invest additional amounts from a salary hike in the National Pension System (NPS). It is a government launched retirement benefits scheme offering asset classes such as equity, government bonds, corporate debt, and alternative investment funds.
To start investing in this scheme, one must mandatorily open the NPS Tier I account. However, the NPS Tier II is a voluntary account. One can choose asset classes under the NPS depending on their risk tolerance. For example, conservative investors focus on government securities and corporate debt. However, NPS caps equity exposure at 75%.
One is eligible for a tax deduction of up to ₹50,000 per financial year under Section 80CCD(1B) of the IT Act, in addition to the Section 80C benefits. Moreover, you can claim a maximum of 10% of your Basic Salary + Dearness Allowance if your employer contributes to the NPS in the employee’s name.
Salaried employees can invest in the Voluntary Provident Fund (VPF) in addition to compulsory Employee Provident Fund (EPF) contributions. VPF is Government-backed, and one can contribute a maximum of 100% of the basic salary and dearness allowance towards this scheme. Moreover, VPF qualifies for the Section 80C tax benefit and offers an interest rate of 8.1% for the Financial Year 2021-22. It is one of the highest interest rates among fixed-income investments. However, one cannot stop VPF contributions before completing the base tenure of five years.
The interest received on EPF or VPF contributions above ₹2.5 Lakh in a financial year is taxed as per applicable income tax slab rates. Moreover, only employees’ contribution is considered for the ₹2.5 Lakh threshold limit. The PF Department deducts TDS at 10% on the interest credited from the taxable EPF or VPF contribution.
You must check the lock-in period of the investments that qualify for the Section 80C tax benefits. For instance, PPF and NSC have a lock-in period of 15 years and five years, respectively. Finally, pick investments that suit your financial needs and then look at tax savings.
Archit Gupta is Founder & CEO of Clear