Tax Saving Instruments
An increasing number of individuals, these days, salaried and non-salaried, are looking for investment options that generate tax-free income and are conducive to savings. The most popular tax-saving opportunities in India fall under the purview of Section 80C of the Income Tax Act.
Section 80C lists the various investments and expenses that can be used to claim deductions. The limit for reducing one’s taxable income under Section 80C is Rs. 1.5 lakh in a financial year. Of all the tax savers, ELSS and ULIP are popular to earn tax-free income. Here is a comparative glance at the two policies:
What is ELSS?
ELSS stands for an Equity Linked Savings Scheme. This is a type of an equity mutual fund wherein at least 80% of total assets are invested in equity and equity-related instruments with a statutory lock-in period of three years. ELSS funds are essentially diversified mutual funds including large cap, small cap and mid cap. It is eligible for tax exemption under Section 80C of the Income Tax Act with a maximum permissible tax exemption of Rs. 1,50,000. The returns on ELSS funds are subject to a long-Term Capital Gains Tax (LTCG) at 10% although gains up to Rs. 1 lakh per year are exempted from tax.
Tax Savings Under ELSS
ELSS funds are exempted from taxes at the time of investment, accumulation and withdrawal (EEE mode). A lock-in period for three years ensures long-term capital gains, which are not taxed for equity investment. Despite being a high-risk instrument — owing to ELSS schemes being non-immune to market fluctuations— ELSS have anticipated costs and better transparency in terms of how the fund operates.
ELSS funds levy a single charge, known as the fund management fee. This is around 3%, and the cost is included in the scheme value instead of being charged separately. ELSS schemes offer another perk: investments in ELSS can be made through monthly SIPs. This makes the investment easy and affordable as a small fraction gets invested every month instead of a lump sum amount.
What is ULIP?
ULIP is an insurance-cum-investment product provided by various insurance companies. In a ULIP, investors have the option to invest partly in equity, debt, hybrid, and money market funds while the remainder provides insurance coverage. This tax-saving tool enjoys tax benefits as per Section 80C of the Income Tax Act. A contribution of up to Rs. 150,000, out of the total investment in ULIP, can be claimed as a tax deduction. These investments have a lock-in period of five years. Investors can switch from equity to debt or hybrid during the tenure of the investment.
Tax Savings Under ULIP
The uniqueness of ULIP schemes lies in the flexibility to invest one’s premium in a mix of debt and equity funds. Inter-fund transfers with zero-tax liability also make it an investor-friendly option. ULIP premiums can be claimed for deduction under Section 80C, provided the premium amount is less than 10% of the sum assured under the policy. The scheme duration can vary between 15 to 20 years or more. The returns generated on maturity or in case of an investor exiting the policy (allowed after 5 years) is also exempted from taxes. However, ULIP schemes do not have a simple cost-vs-benefit equation like ELSS schemes. This is owing to the significant charges incurred in ULIP schemes which include life insurance charges, administration expenses, fund management fees, fund switching charge and service tax. It is the balance amount, which is invested in the market.
Equity investments carry higher risk over the short term, but they offer maximum benefits in terms of wealth creation in the long run. ULIPs are better suited for long-term personal goals as they are not as efficient as investment tools. Keeping higher costs, longer lock-in period and lesser transparency of ULIP schemes in mind, investors may want to pick a plan that aligns with their goals and risk profile.