Saving taxes should not be the only purpose when you  opt for tax-savings instruments. Investment should be made in such a manner that they meet your financial goals. Before you freeze your investment options, you should –

(1)  fix time vision for liquidation linked with your financial goals

(2) know the anticipated returns from different investment avenues to reap maximum benefit 

(3)know the effective return on investment after factoring the tax relief at the time of investment, accrual and exit

The aim of investment planning is to achieve a balance between maximised returns and adequate liquidity. Tax savings should be supplementary to these.

Let us first understand the maximum amount, which you can invest to reduce your tax bill.

Section 80C: The Rs1.5 lakh tax-saving window

An individual taxable at 30 per cent can save around Rs45,000 if she claims Rs1.5 lakh as deduction under section 80C. Some of the investments which you can make are:

1 Provident Fund (PF) contribution:

2 Principal component of your housing loan

3 Tuition fees of up to two children

4 Investment in PPF account

5 Life insurance premium for self, spouse and children

6 Contribution to ULIP for self, spouse and children

7 Invest in National Savings Certificates schemes (through post offices)

8 A 5-year term deposit with a bank under a notified scheme or a post office

9 Investing in Sukanya Samriddhi Yojanain the name of your daughter (limited to two children)

New Pension Scheme: Savings other than Section 80C

The employee’s contribution up to 10 per cent of salary or self-employed individual’s contribution up to 20 per cent of gross total income to NPS is deductible, subject to overall cap of Rs1.5 lakh (which includes investments under Section 80C). An additional deduction of `50,000 is also available on account of your contribution. However, employer’s contribution is fully exempt up to 10 per cent of salary without any cap.

Any investment decision beyond the above should only be driven with return on investment after considering the impact of taxes at exit and liquidity window.

Investment for long-term goals

Most tax-savings related investments are for long-term.

Equity is perhaps the only asset class that has the potential to generate inflation-beating returns. This is where Equity-Linked Savings Schemes (ELSS) play a vital role. While ELSS tend to offer the best in-class return, it may be vulnerable towards volatility. These plans are apt for people who have the risk appetite to stay invested for a long time and provides tax relief under Section 80C. From April 1, 2018, any long-term capital gain (LTCG) above `1 lakh on transfer of equity mutual funds that have an equity exposure of 65 per cent or more including ELSS, will be taxable at the rate of 10 per cent. The LTCG made till January 31, 2018, remains grandfathered, i.e., those gains remain tax-exempt.

Investment in PPF and NPS are other options available for long-term investments. Investment in these instruments provide tax break along with the advantage of generation of tax-free income.

Apt investment for short-term goals

For short-term goals, one should shift to fixed income and debt category products like tax-saving fixed deposits. These have a shorter lock-in period and also provide easy liquidity options along with tax relief. With short-terms goals, the risk appetite of investors is usually very low. Hence, investing in ELSS for such goals may lead to anxiety.

Your criteria to choose an investment product to save taxes should be based on its merits and how it fits into your portfolio. Intelligently created portfolio will definitely create wealth in the long-term and would also help in facing challenging financial situations in the  short run.

The author is a Tax Director, People Advisory Services, EY India