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Save tax and generate tax free income

Smita is an employee at a bank. She was looking into different avenues to save tax as the financial year came to a close. She meticulously analyzed the different tax saving instruments and found out some instruments reduced her tax outgo and gave her additional income. Smita knew that investing in tax saving instruments, could help her reduce her taxable income, but what she did not consider was the taxability of the income earned from them.

If you’re wondering how to save income tax, there are a whole range of investments that allow a deduction of taxable income, which help in reducing the total tax outgo. But which are the best tax saving instruments?

While there are some instruments that help save tax by reducing taxable income, income from them is taxed at regular rates. For example, by investing in National Savings Certificates, Smita will get a deduction under Section 80C. However, the interest earned on them will be taxable. Investing in such instruments means your tax outgo may not be as low as you expect.

However, there are a few tax saving investments whose income is tax free. These incomes are not added to your taxable income.

If you’re looking at how to save tax in India, here is a handy guide of the best tax saving instruments:

• Public Provident Fund (PPF):

The Public Provident Fund is one of the most popular instruments to invest in. It is also one of the safest, since it is backed by the government. The minimum investment for a PPF is Rs. 1,000 whereas the maximum investment per year is Rs. 1,50,000. The interest earned on PPF is exempt from tax. Any withdrawals after maturity of the investment is also tax free.

• Employee Provident Fund (EPF):

The Employee Provident Fund is similar to the Public Provident Fund, except it is for salaried employees. Any interest earned on EPF is exempt as well as withdrawals. This makes it an excellent instrument for retirement.

• National Pension Scheme (NPS):

This is a newly introduced pension scheme where yearly contributions are made to build a corpus for retirement. Contributions to the NPS can be invested in different funds till the subscriber reaches 60 years of age. When he reaches 60 years of age, 40% of the NPS fund amount has to mandatorily be invested in an annuity plan while 60% can be withdrawn tax free. Earlier, 40% of the withdrawal was tax free, but the government changed the provisions in December 2018, providing greater benefit.

• Sukanya Samriddhi Scheme:

This scheme is like a provident fund scheme meant for the benefit of a girl child. The minimum yearly contribution to this scheme is Rs. 500 and the maximum is Rs. 1,50,000. The account can be opened for a child under 10 years of age and will mature when the girl child turns 21. With an interest rate of 8.5%, this is one of the most attractive investments for a minor.

• Life Insurance Policies:

An investment in life insurance policies gives a deduction of up to Rs. 1,50,000 under Section 80C of the Income Tax Act. Any amount received on an insurance policy is exempt from tax. The law does not discriminate between different types of life insurance policies — i.e. term plans, endowment plans, unit linked insurance policies. Any death or maturity benefit received on these plans is tax exempt.

• Equity Linked Saving Scheme (ELSS):

These schemes were introduced to get people to invest in the stock markets. There are many tax saving mutual funds by different fund houses. Investment in these funds leads to a deduction of taxable income up to Rs. 1,50,000. Any gain on the sale of such mutual funds is exempt up to Rs. 1,00,000. Any gain above Rs. 1,00,000 is taxable at 10%. However, since the gains up to January 31st 2018 are exempt or grandfathered, a significant portion of investment gains are exempt for investors.

There are other instruments such as tax free bonds whose interest is exempt, or equity shares, whose dividend is exempt up to Rs. 10,00,000, which also provide tax free income. However, these instruments do not provide any tax benefit while investing. If you’re looking for ways how to save tax, then investing in these instruments is a good place to start.

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