Investments to Reduce Income Tax
An earning citizen of India has to pay income tax every financial year. With the right planning, the tax burden can be reduced. Tax planning is an effective way with which one can save a sufficient amount to enjoy tax exemptions. The Income Tax Act specifies definite taxes that one needs to pay on income earned but by planning investment one can claim deduction on this. In order to enjoy these exemptions, it is important to choose the right investments to reduce income tax.
There are many investment options that could help reduce the tax liability and increase the income you earn. However, before we speak about how you can make investments to reduce income tax, let us first try and understand the basics of income tax.
What is income tax?
Income tax is a type of tax that is imposed on an earning individual. Each year an individual needs to pay a certain amount of tax based on the total income earned by him. This may include earning from salary, property, or business.
The total tax received acts as a source of revenue for the government. The government can use this fund for the welfare of the country. This revenue is invested into the healthcare, agriculture, and education sectors for its development.
The tax levied on earning individuals is monitored on the basis of the Income Tax Act, 1961. The act mentions the tax slabs and rates applicable on these slabs. The act also has subsections that entail the exemptions one can obtain to reduce the tax liability.
What are income tax exemptions?
There are ways with which an individual can reduce the total income on which tax will be calculated. The tax exemptions can help obtain various reductions on the total tax to be paid.
The recent union budget of 2020-21 eliminated the tax exemptions to enable easy tax payment for taxpayers, but it provided flexibility to taxpayers as well. The taxpayer can continue to pay with old tax slabs in order to enjoy these tax exemptions.
If you are planning to continue with old slabs to pay your tax, it is important to inculcate a good saving habit. Investing in the right product can help you enjoy tax exemptions on tax liability. It is thus important to carefully analyze investment choices.
Ways to obtain tax exemptions?
There are different sections and subsections mentioned in the income tax act that helps a taxpayer enjoy exemptions. According to Section 80C, Section 80D, Section 80EE, one can enjoy exemption on investments and these are as below:
- To reduce the total taxable income, one must invest Rs. 1.5 Lakh in a good investment plan.
- One can further claim a deduction of Rs. 50,000 under 80CCD (1b) if he invests into a NPS.
- One can claim a deduction of Rs. 1, 00,000 under section 80D by buying medical insurance.
- Further, it is possible to claim a deduction of Rs. 50,000 under section 80EE on home loan interest.
What are investment options?
In order to claim exemptions on the total tax, one can invest in several investment options. These are tax-saving options that can help claim deductions on tax. There are many investments to reduce income tax in India.
How can investment options reduce income tax?
The government of India supports investment habits. To inculcate good saving habits, it provides an option to claim exemptions for each investment made by an individual from the taxable income.
According to different sections of the Income-tax Act, taxpayers can enjoy deductions on the total taxable income based on the investment they made each financial year. There are different investment plans such as stocks, fixed deposits, public provident funds, bonds, etc. that can help claim these deductions.
Types of investment options
There are so many investment choices available in the market. One must carefully select the best investment plan depending on the requirement and goals. The investment option must not add up an additional burden on an individual rather it must act as a saving option for him. An individual must make good investments to reduce income tax.
Some investment options are:
- Health insurance
Health insurance policies not only help secure your finances in a medical emergency but also help obtain tax deductions under section 80D. However, there are certain formalities one needs to complete in order to obtain health insurance. - Bank fixed deposits
Fixed deposits in the bank are the most secure type of investment choices that helps obtain tax deductions. It has a five-year lock-in period and qualifies for a tax deduction within the total limit of INR 1.5 lakhs of 80C. - ULIPs
Unit-linked insurance plans come up with the benefit of both insurance and investment. Further, they also help obtain tax deductions. Premiums paid upto INR 1.5 lakhs a year can be exempted from income tax under section 80C. - Public Provident Fund
Investing in a public provident fund is a good choice to enjoy tax-saving benefits. It is easy to open a PPF account in a bank. The next step is to transfer funds from the linked savings bank account. Yearly contributions upto INR 1.5 lakhs can be exempted from income tax under section 80C. - Home loan repayment
Home loans can help claim tax deductions. Tax deductions can be obtained on the principal amount to be repaid on the home loan. Tax deductions can also be obtained on interest paid. - Life insurance
Another viable option to obtain tax deduction is by investing in a suitable term life insurance plan. All life insurance premiums paid upto INR 1.5 lakhs a year can be exempted from income tax under section 80C of the Income Tax Act.
The different investment options can be better understood by the following table:
|
Investment options |
Returns | Lock-in Period |
| 5-Year Bank Fixed Deposit | 6% to 7% |
5 years |
|
Unit Linked Insurance Plan (ULIP) |
Varies with Plan Chosen | 5 years |
| Senior Citizen Saving Scheme (SCSS) | 7.40% |
5 years |
|
National Pension System (NPS) |
12% to 14% | Till Retirement |
| Public Provident Fund (PPF) | 7% to 8% |
15 years |
|
National Savings Certificate |
7% to 8% | 5 years |
| Sukanya Samriddhi Yojana (SSY) | 7.60% |
N/A |
|
ELSS Funds |
15% to 18% |
3 years |
How do you select the best investment options?
To enjoy maximum deduction on the tax liability, it is important to choose the best investment option. It is always a good practice to plan your investment right at the beginning of the financial year. Most taxpayers ignore the importance of investment in the initial months and thus end up choosing inappropriate investment plans at times when taxes are to be paid.
Investment is an important task that requires proper planning and research. One can choose the best investments to reduce income tax. The right investment option is like an additional perk. It is thus important to ensure this before investing:
- Make a list of tax-saving options you have. This may include insurance premium, EPF contribution, home loan repayment, and child education fees, etc.
- Now add them all and subtract it from 1.5 lakh to know how much more you need to invest to claim for a tax deduction.
- Now make the list of new tax options and analyze their risk profile.
- On the basis of your goals, choose the best option to invest in.
Conclusion
When you have already made up your mind to pay your tax with the old tax slabs, it is important to plan your investments to reduce income tax. It is crucial to check for different investment options before selecting the best possible choice to enjoy maximum deductions on your tax liability.
