Which investments are 100% tax-free
28 Mar 2024 7 mins Tax Planning
When people want to save money and pay less in taxes, they often look into different ways to do it. But here's something important to know: not all the options that claim to save you taxes actually make you completely tax-free. It's easy to think they do, but that's not always the case. It's like assuming all umbrellas will keep you dry in a storm—they might help, but they won't necessarily keep you completely dry. So, it's smart to understand exactly how much tax you're saving with each option before counting on it too much.
Investments can indeed be a smart way to save on taxes, but they're rarely entirely tax-free. Even though certain investment options offer tax benefits, they often come with their own set of limitations and conditions. It's essential to understand these constraints to make informed decisions. Take popular tax-saving instruments, for instance. While they can help reduce your tax liability, they typically have specific rules and restrictions that investors need to navigate. From contribution limits to withdrawal penalties, there are various factors to consider before choosing the right investment avenue for your financial goals.
let's dive into why not all investments are entirely tax-free
Let's start with the National Pension Scheme.
The National Pension Scheme (NPS) stands out as a retirement-focused investment avenue that offers significant tax benefits to individuals under the Income Tax Act. Specifically, contributions made towards NPS qualify for tax deductions under two sections of the Act: Section 80C and Section 80CCD(1B). This means that individuals can reduce their taxable income by the amount they invest in NPS, subject to certain limits specified by the tax laws.
However, while NPS contributions provide immediate tax benefits, the taxation treatment of the maturity amount is different. Upon reaching retirement age or upon attaining superannuation, individuals are allowed to withdraw a portion of their NPS corpus. However, only 60% of this corpus is tax-exempt. This means that 40% of the accumulated corpus is subject to taxation at the time of withdrawal. The tax applicable to this 40% portion is determined based on the individual's applicable income tax slab at that time.
Equity Linked Savings Scheme (ELSS):
ELSS investments are primarily equity-oriented mutual funds, and like other equity investments, they attract long-term capital gains tax if held for more than one year. However, ELSS funds are unique in that they enjoy a special tax treatment under LTCG tax rules.
Under the current tax laws in India, individuals do not incur LTCG tax on capital gains from ELSS funds up to Rs 1 lakh in a financial year. This means that if the capital gains realised from the sale of ELSS units in a financial year are within the Rs 1 lakh threshold, no LTCG tax is applicable, and the gains remain tax-free.
However, any LTCG exceeding the Rs 1 lakh threshold is subject to long-term capital gains tax at a rate of 10% without indexation. Therefore, while the initial Rs 1 lakh of LTCG from ELSS investments is tax-free, any gains beyond this limit are taxable.
Tax Saver Fixed Deposit (FD):
Investors often favor Tax Saver FDs due to their ability to offer tax deductions under Section 80C, especially if they're risk-averse. However, it's worth noting that the interest earned on these FDs is fully taxable, which somewhat offsets the initial tax-saving benefits.
Furthermore, investors should be aware that premature withdrawals aren't permitted with Tax Saver FDs, limiting liquidity options.
Health Insurance:
Under Section 80D of the Income Tax Act, premiums paid for health insurance policies are eligible for tax deductions, providing a financial incentive for individuals to secure health coverage.
However, this deduction is subject to specified limits depending on the policyholder's age, the type of coverage, and other factors. It's important to note that the tax benefit applies only to the premium amount and does not extend to any other expenses covered by the policy, such as medical treatments or hospitalization costs.
Senior Citizen Savings Scheme (SCSS):
Senior Citizen Savings Scheme (SCSS) presents enticing interest rates and tax advantages under Section 80C. Nonetheless, it's important to note that the interest gained from SCSS is subject to taxation based on the individual's tax bracket.
Additionally, the maximum investment ceiling for SCSS stands at 30 lakhs, which somewhat restricts its capacity for wealth growth when compared to alternative investment avenues.
Education Loan:
Under Section 80E of the Income Tax Act, you can claim deductions for the interest you pay on education loans taken for higher studies for yourself, your spouse, or your children. It's worth noting that while the interest payments offer tax benefits, the principal repayment of the education loan doesn't qualify for such deductions.
House Rent Allowance (HRA):
When it comes to House Rent Allowance (HRA), it's like a little bonus from your employer to help with your rent expenses. To get tax exemptions on this allowance, you gotta follow some rules laid out in Section 10(13A) of the Income Tax Act.
Basically, you need to prove you're actually renting a place and keep records of the HRA you receive. How much exemption you get depends on factors like how much HRA you're getting, the rent you're paying, and your overall salary setup.
Life Insurance Policies:
Now, let's talk about life insurance policies. They're not just about securing your loved ones' future; they can also give you some tax benefits. Under Section 80C, the premiums you pay can help reduce your tax burden.
Plus, when your policy matures, the money you get can be tax-free under Section 10(10D). But here's the catch: if the amount assured in your policy is less than 10 times the annual premium, you might end up with some tax on the maturity proceeds. So, it's wise to check that your policy meets this threshold to enjoy tax-free benefits down the road.
Let's dive into investments that are completely tax-free.
Public Provident Fund (PPF):
PPF has long been a favorite among Indian investors for its triple tax advantage. Contributions made towards PPF are eligible for tax deduction under Section 80C of the Income Tax Act. The interest earned on PPF is tax-free, and the maturity proceeds are also exempt from tax. This triple tax exemption makes PPF a compelling choice for long-term wealth creation and retirement planning.
The tax-free status of PPF can be attributed to its classification as an Exempt-Exempt-Exempt (EEE) investment. This means that contributions, accruals, and withdrawals are all exempt from tax, making it one of the most tax-efficient investment avenues available.
Sukanya Samriddhi Yojana (SSY):
SSY is specifically designed to promote the welfare of the girl child in India by providing a long-term savings avenue with attractive tax benefits. Contributions made towards SSY qualify for tax deduction under Section 80C, similar to PPF. Furthermore, the interest earned and the maturity proceeds from SSY are completely tax-free.
The tax-free nature of SSY serves as a powerful incentive for parents to invest in their daughters' future financial security. By providing tax-free returns, SSY ensures that the accumulated corpus can be utilized for the girl child's education, marriage, or any other significant life event without any tax implications.
Employees Provident Fund (EPF):
EPF is a retirement savings scheme mandated by the government for salaried employees in India. Both the employer and the employee contribute a certain percentage of the employee's salary towards EPF every month. Contributions made towards EPF qualify for tax deduction under Section 80C, making it a tax-efficient investment avenue.
Apart from the tax deduction on contributions, the interest earned on EPF accumulations is also tax-free. Additionally, the maturity proceeds from EPF are exempt from tax if the withdrawal is made after five years of continuous service. This tax-exempt status makes EPF a cornerstone of retirement planning for millions of salaried individuals in India.
Voluntary Provident Fund (VPF):
VPF is an extension of EPF that allows employees to contribute more than the mandated percentage of their salary towards their EPF account voluntarily. Similar to EPF, contributions made towards VPF qualify for tax deduction under Section 80C. The interest earned on VPF contributions is tax-free, and the maturity proceeds are also exempt from tax if withdrawn after five years.
The tax-free nature of VPF makes it an attractive option for employees looking to enhance their retirement savings beyond the regular EPF contributions. By voluntarily contributing more towards VPF, individuals can enjoy higher tax savings and build a larger corpus for their post-retirement years.