Which is the best Tax Saver investment for you?


Hopefully you have read our beginner's guide to investing under section 80C to understand what all of it means. In this post we will look at some of the most popular tax saving investment options and how they compare with each other so that you can decide which one is the best for you.

We will cover only the very popular ones mentioned below:

  • PPF
  • Tax Saving 5-Year Fixed Deposit
  • Pure/Term Life Insurance
  • Money-back Life Insurance (Endowment plans)
  • ULIPs
  • Tax Saver Mutual Funds (ELSS)

This is not a complete list of all eligible 80C tax saving investments, there are more (although they may not be relevant to everyone) and you can find the complete list here.

1. PPF (Public Provident Fund)

Pros:

  • Fixed Interest as decided by Govt of India every year (slightly higher than current FD rates)
  • Safe and stable
  • Interest earned is also not taxable

Cons:

  • Very long lock-in ~ 15 years
  • Low returns (only slightly higher than inflation)

It does not make much sense to lock away your money for 10-15 years in PPF as it gives returns only slightly higher than inflation. It is simple and safe but only because it does not offer much. However, if you are the totally risk averse type, then you can consider this option.

Verdict: Only for the very low risk tolerant and if you don't mind the long lock-in period. Most others would do better either going with a Tax saver FD or a Tax Saver Mutual Fund.

2. Tax Saving 5-Year Fixed Deposit

Pros:

  • The good ol' FD - safe and stable
  • Lock-in of just 5 years
  • Interest rate fixed at the time of investment

Cons:

  • Low returns (at par of slightly more than inflation)
  • Interest earned is taxable - so after-tax returns are even lower

Well, if this money is absolutely the ONLY savings you have, you should probably choose the Fixed Deposit option. The lock-in is on the shorter side and there are no short-term ups and downs thus giving you the stability and peace of mind that your only savings should. Although bear in mind that the interest earned is taxable so the effective returns you will make will be lower.
If you don't mind a long lock-in of 15 years then go with PPF as the interest earned in your PPF is not taxable.

Verdict: Do this when investment returns don't matter much to you as long as the investment is safe and you want the money to be accessible soon.

3. Pure/Term Life Insurance

Term Life Insurance is the one where you don't get any money back at the end of the maturity period similar to health or car insurance. This is a pure insurance product as opposed to an insurance-cum-investment product.

Pros:

  • Best kind of life insurance available
  • Cheap - Rs 5000 can get you a life cover of about Rs 50 lakhs.

Cons:

  • It is an insurance, not an investment
  • Cannot exhaust the entire 1.5 lakh limit just from term insurance
  • If you don't have any dependents then you probably don't need it

Verdict: If you have any dependents i.e. people who are dependent on your income for their life expenses (e.g. your partner, your children), then you should definitely get a Term Insurance Plan for 5k-10k at least. This would give you a life cover of 50 lakhs-1 Crore. If you don't have any dependents, then there is no need to get one yet.

4. Money-back Life Insurance (Endowment plans)

These are the policies where the insurance agent tells you that if you invest 20,000 every year for 20 years you will get 20 lakhs at the maturity or some such combination of numbers which are mostly lies.

Pros:

  • Honestly cannot think of any advantages

Cons:

  • Long lock-in periods (>15-20 years)
  • Returns not more than 5-6%
  • Expensive Insurance
  • Non transparent
  • High hidden fees
  • Rigidity - have to continue investing year after year or the entire policy will lapse

Truth be told, insurance-cum-investment policies give you the worst of both worlds. If you actually read the fine print in the policy offer document before buying, you wouldn’t touch them with a 10-foot barge pole. If you already have bought one then you will feel like suing the salesperson for misguiding you. Why? First of all, any sort of returns is NOT guaranteed (apart from the insurance cover). The numbers and tables used by most salesmen while selling such plans are hypothetical and are not guaranteed no matter what they tell you (If you don’t believe us ask them to show you where it says so in the offer document. They won’t be able to). In most cases insurance-cum-investment plans actually give returns that are even less than rate of inflation.

What about the insurance part? Insurance-cum-investment plans offer a fraction of the insurance cover that term insurance (pure life insurance with no money back like a car insurance) does, for a much higher premium. The difference is mind-boggling. The cover you get for paying 20,000 per year in a popular insurance-cum-investment plan is about 5 lakhs. In a term plan, for just Rs 5000 per annum you can get a cover of about 50 lakhs. So for 5 lakhs, the equivalent number is just Rs 500! These policies are clearly the worst place to park your money in for any period of time, forget 15-20 years.

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Verdict: Popular only because of mis-selling. Highly avoidable. One of the worst products.

5. ULIPs (Unit Linked Insurance Plans)

If you see the word insurance anywhere except in a term insurance plan, just run away from it. Seriously.

Pros:

  • The second-worst option (after Money-back insurance policies)
  • Lock-in of 5 years
  • Stock-market linked so has the potential of giving higher returns

Cons:

  • Stock-market linked volatility (ups and downs) in investment value
  • Higher fees than a Mutual Fund (even after accounting for the cost of insurance)
  • Complicated list of one-time and hidden charges
  • Actual returns available to the investor lower than a Mutual Fund
  • Obligation to keep paying future premiums for the same ULIP or the policy will lapse.

The last point needs a bit of explaining to understand its importance -
With ULIPs you are obligated to pay the premiums every year for the same ULIP or they will lapse. So essentially, when you sign-up for a ULIP, you are signing up for doing tax saving through that same ULIP for the future as well, no matter how bad it may be. This is the reason why many investors feel stuck with a ULIP after they have purchased it.

Overall, ULIPs are just less flexible and costlier (more commission for the salesperson) versions of Mutual Fund investments and this is the reason why your friendly neighbourhood financial advisor or bank representative tries hard to sell them to you. More commissions for them, less returns for you.

ULIP costs = Insurance costs + Mutual Fund costs + Extra costs mostly hidden in the fine print (at least 5-6% extra for the first 5 years)

Verdict: Avoid like plague. Another of highly mis-sold products. Read the fine print.

6. Tax Saver Mutual Funds (ELSS)

Pros:

  • Shortest lock-in amongst all - 3 years
  • Stock-market linked so they give higher returns in the long term
  • Transparent fees and performance tracking
  • no obligation to keep paying future 'premiums' - you can choose a different Mutual Fund every year or not choose at all

Cons:

  • Stock-market linked volatility (ups and downs) in investment value

Stock markets despite their short-term ups and downs are actually a good place to look for inflation-beating returns in the long term. Why should that be the case? Because for a growing country, the amount of business that gets done in the country increases beyond just inflation otherwise there is no real growth. The real GDP growth of India (which has been close to 6-7% above inflation) results in higher revenues, higher profits and eventually higher stock prices for companies.

Between the two stock market linked products, ELSS easily wins over ULIPs as they are more transparent, more flexible, have lower overall commissions and have a shorter lock-in period of just 3 years.

Moreover, with Mutual Funds you don't have any obligations for the future. You are free to choose any other ELSS Mutual Fund (or any other tax saving investment option for that matter) for next year's tax saving and it won't affect your past tax saving.

Verdict: If you are not the totally risk-averse type - go for Tax Saver Mutual Funds. There will be gains and losses in the short term but eventually you will come out way ahead of your PPF-ing and LIC-ing peers.

How much ahead you ask - ELSS have given almost 7-9 times more returns than PPF over the last 15 years!
Go figure.

A comparison summary of the popular tax saving investment options

Comparison of various Tax Saving Investment Options

Btw, did you know that a part of your home loan EMI also qualifies for section 80C (the part equal to principal payment)? Before you invest the entire 1.5 lakhs in one of the investments above, consult your CA or tax advisor to find out how much extra do you need to invest to avail the entire exemption of 1.5 lakhs under section 80C.

We have also built a simplified handy tool for it using which you can find out how much you can save in taxes now!

Disclaimer: The information related to tax saving presented on Goalwise is general in nature. Please consult your tax advisor or CA for accurate tax advice related to your particular situation.