A jargon-free and simplified guide to understanding tax saving investments (under section 80C)
Q. What is this '80C' thing?
It is a section of the Indian Income Tax Act which provides for some exemptions that you can use to lower your net payable income tax to the Government of India.
Q. Why would the government want us to save on taxes payable to them?
Surprising, right? Well, this is to promote long-term savings amongst the tax payers. Our savings whether in FDs or in EPF/PPF or Mutual funds, increases funds available for the economy in general (eg banks give out loans from the money they receive in FDs), thus helping in the country's growth.
This is also why all eligible things you can invest in to avail 80C exemptions have a lock-in of a few years at least.
Q. How do these exemptions actually work? As in what exactly gets exempted and how?
The amount that you invest gets exempted from being counted as part of your taxable income. For eg, if your annual income is 5 lakhs and you invest 1 lakh in 80C eligible investments, then for the current financial year, your taxable income would only be counted as 5-1 = 4 lakhs. For income tax calculations, it would be as if you earned only 4 lakhs this year and not 5 lakhs - hence lower income tax bill.
Q. Is there a limit to how much I can invest for tax exemption under 80C?
You bet. The limit is Rs 1.5 lakhs per person per financial year as laid out in section 80C itself.
Q. Okay, so lets say I have an income of 12 lakhs and I invested 1.5 lakhs under 80C. How much did I save in taxes?
Already counting your chickens ha!
Well, if you dint invest 1.5 lakhs under 80C, your taxable income would be 12 lakhs. The tax paid would be approximately - (0 for first 2.5 lakhs) + (10% of income falling in the 2.5 to 5 lakhs bracket) + (20% of income falling in the 5 to 10 lakhs bracket) + (30% of income above 10 lakhs) = 0 + 25k + 1 lakh + 60k = 1.85 lakhs
Now, after you have invested 1.5 lakhs under 80C, your taxable income would be 10.5 lakhs. The tax paid would be approximately - (0 for first 2.5 lakhs) + (10% of income falling in the 2.5 to 5 lakhs bracket) + (20% of income falling in the 5 to 10 lakhs bracket) + (30% of income above 10 lakhs) = 0 + 25k + 1 lakh + 15k = 1.4 lakhs
Tax Saved = 1.85 lakhs - 1.4 lakhs = 45k
More generally, the savings would depend on the tax bracket that you are in and how much you are investing, with the max being around 45k (ignoring surcharges). Not bad, right?!
Q. How does the government know I have saved under 80C?
Simple - you tell them via your income tax return filing. Its a self-declaration although you should maintain the investment proof, should your HR/CA or even IT authorities ask for it later.
Q. How will I get this savings? Is the government going to put the tax saved in my account like some cash back? :D
Well, that depends on how much you have paid in income taxes for the current financial year.
If your employer already took this into account (because you declared to your HR at the beginning of the year that you are going to make these investments), then your TDS every month was anyway lower and you got a little extra every month.
If you have been paying tax on your full income and you finally made these 80C investments, then you have overpaid and you can claim a refund in your income tax return filing and it will be credited back to your bank account once your returns have been processed by the IT dept (Income Tax department and not the office you work in :D). Cash back - hell yeah!
Q. This sounds terrific! How do I make these 80C investments? I just did an FD in a bank - will it work?
Most probably not. There are very specific investments that are eligible for these exemptions.
Section 80C specifies the entire list of eligible investment products that one could use to avail of the exemptions. The most popular ones are:
1) PF/EPF - only your contribution to it is counted towards 80C (and not your employer's)
3) All Life Insurance Policies
4) All Unit-Linked Insurance Plans (ULIPs)
5) Special 5 year Tax Saver FDs (not all 5-year FDs)
6) Special Tax Saver Mutual Funds known as ELSS (not all mutual funds)
You could make any or all of these investments - but the grand total across all can not exceed 1.5 lakhs for exemption.
Q. Well that's a lot of choice. How do I know which one is good for me?
If you are very risk-averse, go for PF/PPF or tax saver FDs. If you can take some ups and downs but want higher returns then go for Tax Saver Mutual Funds.
Apart from the risk and returns, the lock-ins also vary from product to product. For eg PPF/LIC etc generally have lock-ins of 10 years or more, where as Tax Saver Mutual Funds have a lock-in of just 3 years (the lowest)!
Q. Okay, so the investment I make is exempt from taxes now. What about when the investment matures? Will I have to pay taxes then?
At the time of withdrawal, the original investment is still tax-free. However, the taxability of gains made differs from product to product. In the products listed above, apart from the Tax Saver FD and Tax Saver Mutual Funds, the gains made are also completely tax-exempt i.e. the entire amount that you can withdraw will be tax free.
In case of Tax Saver Mutual Funds also, gains upto Rs 1 lakh will be tax exempt every FY. Beyond that there will be a 10% tax on the excess gains.
For example, if you invested 1.5 lakhs in a Tax Saver Mutual Fund and after 3 years it has become 2.5 lakhs and you withdraw it and you don't have any other gains for that year then you have to pay 0 taxes - nothing, nada!
You can read more about Mutual Fund taxation here.
Q. I already some Life insurance, some EPF contribution. How much can I invest and save more?
You can use our handy taxtool to figure out. Easy peasy!
Q. Okay I have figured all this out. Now how do I make these investments?
If you want to do an FD or PPF - you can do it online with your bank
If you want to buy more insurance or ULIPs - you can go the respective websites of the company whose insurance/ULIP you want to buy.
If you want to invest in Tax Saver Mutual Funds - use your favourite Mutual Fund investing platform :)
Don't forget to get your 80C certificate of investment too when you do so.
Q. Can I invest in any Mutual Fund for getting exemptions under 80C?
No! All Mutual Funds don't qualify for tax saving under 80C. Only some specific ones do - they are called as Tax Saver Mutual Funds or ELSS (Equity Linked Savings Schemes). Confirm with your investment adviser before you make any such investments.
I thought I will do this post in a Q&A format rather than a write-up. Let me know in the comments if you found this format more helpful. :)
Disclaimer: The information contained herein is meant for educational purposes and does not constitute professional tax advice. Please consult your tax advisor before making any tax related decisions.