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Tuesday, Mar 01, 2005

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Tax savings: Choices galore

Suresh Krishnamurthy

THE Budgets presented over the past few years had but one larger message for the retail investor: Invest more in equities. Budget 2005 seeks to facilitate such investments.

The revamp of personal tax laws proposed by the Finance Minister will have the effect of opening up a wide array of investment choices for the investor, including equity mutual funds and pension plans. The proposed changes will also allow investors to plan their investments and asset allocation with a long-term perspective.

Until now, savers had no option but to consider provident funds, national savings certificate and infrastructure bonds to avail themselves of tax savings. The limits for investments in mutual funds and pension plans were restricted to Rs 10,000 each. Savers had to endure the mortification of seeing the coupon rates on bonds come down to less than 6 per cent. Even in the case of non-tax saving investments, there was distortion caused by Section 80-L.

The proposed dispensation unshackles savers. They can now earn more by investing in options that are more competitive and at the same time avail themselves of tax benefits. They can explore a wide array of choices for the Rs 1-lakh limit.

In addition, the changed tax rates and slabs will leave more cash in the hands of the investor. First, lower taxes will leave about Rs 15,000 and Rs 20,000 in the hands of investors earning Rs 2 lakh and Rs 3 lakh, respectively. In addition, if you invest Rs 1 lakh, the tax saved will add Rs 5,000 and Rs 15,000, respectively to the savings compared with what such savings provided in the previous year. Judging by the propensity of Indians to save, a proportion of those sums will no doubt be saved.

Optimal plan

In the new order, the mandated saving in the form of contribution to employee's provident fund and contribution to provident fund and pension fund in the case of government employees will take a portion of the Rs 1-lakh limit. Tuition fees paid for children will also consume a portion of the limit. It makes sense to utilise the remaining proportion first for payment of housing loan principals. That would reduce the cost of housing loan further, and notwithstanding the rise in interest rates on housing loans, it makes more sense to go in for a housing loan now.

A proper asset allocation plan needs to be designed for the rest of the amount at disposal. As far as possible, investors should commit funds for as long a term as possible. Until now, investors invest for as short a term as possible. This allows the investors to re-invest the same in tax-saving investments. Now, they can and should think long-term.

Attractive options

Equity mutual funds, pension plans and provident funds stand tall in terms of attractiveness. This is because of their long-term orientation and their tax efficiency. The returns from these plans continue to be tax exempt. In contrast, infrastructure bonds and National Savings Certificate may need to be avoided. The interest earned on these options will suffer tax, lowering the return in the process.

With respect to asset allocation, a conservative investor should probably explore with an allocation of up to 30 per cent for equities. A systematic investment plan for investing in equity mutual funds can be considered. The debt portion can be split between pension plans that invest entirely in debt and provident funds. Employee provident fund, which seeks to offer higher returns than the public provident fund, is relatively more attractive.

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