Tax Planning Options for Aggressive Investors

[Tax Planning Series]

Session 2: Tax Planning Options For Aggressive Investors

We are glad to have you with us for our 2nd Session on Tax Planning – and that is ‘Tax Planning Options for Aggressive Investors’

Alright so let’s get started...

Often many individuals wait till the eleventh hour to do their tax planning. Feeling the heat to do tax planning as the financial year draws to a close, they buy any and every tax saving investment product, without really recognising what’s the most appropriate for them. In the bargain, this leads to mere ‘tax saving’ rather than ‘tax planning’.

Under “tax planning” one’s larger financial plan after accounting for one’s age, financial goals, ability to take risk and investment horizon are considered. Hence, it is vital to complement tax planning with investment planning so that financial goals can be achieved holistically.

In this session of Money Simplified, we will explain how aggressive investors or risk takers can go about doing their tax planning.

Tax Planning Options for Aggressive Investors
So, let’s begin with our today’s session and first let’s understand who can be classified as an aggressive investor or a risk taker.

Typical Traits of an aggressive investor

  • Typically young;

  • Has a high source of income;

  • Has created or is in the process of creating considerable assets ;

  • Is willing to accept the risk of short term losses to create long term wealth

  • Has limited liabilities

  • Is not supporting many dependents ;and

  • Most financial goals are far away

Tax saving investment avenues for aggressive investors

If you match traits of an aggressive investor or one who can afford to take risk, market-linked tax saving investment instruments would be suitable for you.

Market-linked tax saving instruments invest in the capital markets and offer a variable rate of return. The returns aren’t fixed.

Let’s discuss the market-linked tax saving instruments; which you may consider...

  • Equity Linked Saving Schemes (ELSS)

  • Also known as tax saving mutual fund schemes, are by far popular amongst individual investors and HUFs, who intend to create wealth through higher inflation-adjusted returns. A distinguishing feature about them are:

  • Comes with a lock-in period (of 3 years)

  • Minimum investment of Rs 500 can be made with no upper limit

  • Both lumpsum and SIP mode available for investing (If SIP mode is opted for benefit of compounding and rupee-cost averaging , each unit will need to complete the lock-in period)

  • Withdrawals are allowed post lock-in; and

  • Dividend and capital gains are tax-free

  • The amount invested in ELSS qualifies for deduction u/s. 80C (of Income Tax Act, 1961) upto a sum of Rs 1.50 lakh p.a.

  • While selecting Equity Linked Savings Scheme (ELSS), you may give importance to those which have completed at least 5 years of track record and are from mutual fund houses that follow strong investment policies and processes. Don’t get lured just by returns, because there’s more to evaluating a mutual fund scheme than just returns. Pay attention to risk taken to generate the returns, portfolio turnover, expense ratio and other portfolio characteristics.

  • Unit-Linked Insurance Plans (ULIPs)

    • Equity oriented plans – These is a market linked investment instrument offered by insurance companies

    • They have a lock-in period of 5 years

    • Capital gains post lock-in are tax free

    • Minimum investment of Rs10,000 is required

    But ideally insurance and investment needs should be dealt separately via term insurance and mutual funds respectively, to ensure optimum insurance coverage.

    The premium paid for ULIPs qualifies for a deduction u/s. 80C (of Income Tax Act, 1961) subject to the maximum eligible amount of Rs 1.50 lakh p.a. Also, at maturity the amount received (by you or your beneficiary) is exempt from tax u/s. 10(10D) of the Income Tax Act, subject to specified conditions.

  • National Pension System (NPS)

  • One can voluntarily contribute/invest in National Pension System (NPS) through various intermediaries so as to build a retirement kitty.

    There are two accounts – Tier-I and Tier-II

    Tier-I Account:

    • In this account, minimum investment is Rs 500 per contribution and Rs 6,000 a year

    • Minimum 1 contribution in a year is required

    • Premature withdrawal is not permitted before you attain 60 years of age. If one retires before 60 years, then 80% of the amount accumulated has to be utilised by you to buy a life time annuity.

    • After 60 years, 40% of the amount accumulated has to be utilised to buy a life time annuity.

    • Tier-II Account:

    • For opening this account, minimum investment is Rs 1,000 per annum

    • Minimum 1 contribution in a year is required subject to minimum contribution of Rs 250. If you open an account in the last quarter of the financial year, you will have to contribute only once in that financial year.

    • You will be required to maintain a minimum balance of Rs 2,000 at the end of the financial year. Moreover, in order to have Tier-II account, you first need to have a Tier-I account. Tier-II account is a voluntary account and withdrawals will be permitted under this account, without any limits.

  • Even if you hold both the NPS account, only the Tier-I account are eligible for tax benefits.

  • As an investor you have two investment choices: Active or Auto.

  • Under the Active option you have a choice to decide the asset allocation to equity (E), Credit risk bearing fixed income instruments (C) and Government bonds (G). As an aggressive investor, you should ideally be investing in equity. But the maximum allocation to equity is capped at 50%, which is a limitation for someone who is young and can afford to take risk.

  • If you opt for Auto choice, money will be invested in these asset classes in accordance with the predetermined asset allocation and age.

  • Non-Resident Indians (NRIs) can also participate in NPS

  • If you are a salaried individual, deduction upto Rs 1.50 lakh can be claimed u/s. 80CCD(1).

    An additional deduction can be claimed u/s. 80CCD(2) if there is any contribution made by the employer but only upto 10% of their salary (for this purpose, salary construes, Basic Salary plus Dearness Allowance)

    In the Union Budget 2015-16, the Government inserted a new sub section 80CCD(1B) in section 80CCD which provides additional deduction of Rs 50,000 for contribution made by Individual assessee under NPS.

    In case of NPS, capital gains are taxed on withdrawal

    While NPS enables investors to plan for their retirement needs, it may not be able to meet all retirement needs. Hence holistic retirement planning would be needed.

  • Rajiv Gandhi Equity Savings Scheme

  • Rajiv Gandhi Equity Savings Scheme (or RGESS) was introduced in the Finance Act, 2012, under Section 80CCG provides for deduction for investment in RGESS

  • One can avail a Deduction under RGESS scheme provided you are new retail investors who comply with the conditions of the scheme and whose gross total income for the financial year in which the investment is made under RGESS is less than Rs 12 lakh. New retail investor’ interalia shall mean any resident Individual who has not opened a demat account

  • The maximum Investment permissible for claiming deduction under RGESS is Rs 50,000

  • As an investor you would get a 50% deduction of the amount invested from the taxable income for that year u/s 80CCG. The benefit is in addition to deduction available u/s Sec 80C

  • Investments are to be made directly in eligible listed equity or Follow on Public offer of such listed equity or into units of mutual funds and ETFs

  • The total lock-in period for investments under the RGESS would be divided into 'fixed lock-in period‘ and 'flexible lock-in period’. The initial period of lock in shall be known as Fixed Lock-in Period, which shall commence from the date of purchase of such securities in the relevant financial year and end on the 31st day of March of the year immediately following the relevant financial year. A new retail investor shall not be permitted to sell, pledge or hypothecate any eligible security during this fixed lock-in period. The period of two years beginning immediately after the end of the fixed lock-in period shall be called the flexible lock-in period. Upon completion of the fixed lock-in period, new retail investors would be allowed to trade in the eligible securities. Investors would, however, be required to maintain their level of investment during the next two years (i.e. the flexible lock-in period) at the amount for which they have claimed income tax benefit or at the value of the portfolio before initiating a sale transaction, whichever is less, for at least 270 days in each of these 2 years. Such investment value shall exclude the value of investment which is under the fixed lock-in period.

  • Here’s a snapshot of the market-linked tax saving instruments which we discussed...

Market-linked tax saving instruments for aggressive investors: A snapshot
Schemes Tenure / Lock-in Min – Max Investment Premature Withdrawal Current Tax on returns
Equity Linked Savings Scheme (ELSS) No limit on tenure, Lock-in-period: 3 years Varies from scheme to scheme. Can range from Rs 500 - No upper Limit Withdrawal allowed post lock-in Dividend & Capital gains are tax free
Unit Linked Insurance Plans (ULIPs) – Equity oriented plans Tenure: 10 - 20 years;Lock-in-period: 5 years Premium varies from scheme to scheme Yes Capital gains post lock-in are tax free
National Pension System (NPS)
Active Choice, Option’ E’
Tenure: 30-35 years (for Tier-I a/c); Lock-in till 60 years^ Rs.500 per month or Rs 6,000 per annum, no upper limit Yes, but allowed only in Tier-II a/c Capital gains taxed on withdrawal
Rajiv Gandhi Equity Savings Scheme (RGESS) No limit on tenure, Fixed lock-in periodFlexible lock-in period No limit on the maximum investment (but maximum Investment permissible for claiming deduction u/s. 80CCG is Rs 50,000 Yes* Capital gains post lock-in are tax free
All information is as of December 31, 2015
*permitted only during the ‘flexible lock-in period subject to specified conditions
^ If one retires before 60 years, then 80% of the accumulated amount must be utilised to buy life time annuity

Here are the final...

Points to remember...
  • Don’t wait till the eleventh hour to do your tax planning as by doing so you’ll buy any and every tax saving investment product

  • Market-linked investment products which clock a variable rate of return are suitable only if you are a risk taker / aggressive investor

  • You can start investing in ELSS with as little as Rs 500

  • ULIPs offered by insurance companies look at both insurance and investment but ideally consider separating insurance and investment needs through mutual funds and term insurance

  • Even if you hold both the NPS accounts, only the Tier-I account are eligible for tax benefits

  • Only new retail investors whose gross total income in a financial year is less than Rs 12 lakh can invest in RGESS

  • Complement tax planning and investment planning

[This video transcript is dated February 17, 2016.]

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