Best ways to save taxes: ELSS, NPS, ULIPs and 7 more investment options to maximise your tax saving this year Depending on your requirements, here is a list of tax-saving instruments you can invest in, ranked according to returns, safety, flexibility, liquidity, costs, transparency, ease of investment, and income taxability offered by each one of them. Read on to know more
It is peak winter, but the taxpayers who haven’t completed their tax planning for the year are sweating it out. With the last date for submitting proof of taxsaving investments around the corner, many are struggling to figure out where to invest. If you are among them, here’s some help. ET Wealth’s annual ranking of tax-saving instruments can help you zero in on the best option. We assessed 10 popular tax-saving options on eight key parameters—returns, safety, flexibility, liquidity, costs, transparency, ease of investment and taxability of income. Each parameter was given an equal weightage and the composite scores determined the place in the ranking.#sr_widget.onDemand p, #stock_pro.onDemand p{font-size: 14px;line-height: 1.28;} .onDemand .live_stock{left:17px;padding:1px 3px 1px 5px;font-size:12px;font-weight:600;line-height:18px;top:9px} #sr_widget.onDemand .sr_desc{margin:0 auto 0;} #sr_widget.onDemand .sr_desc{color: #024d99;margin-top:10px;} #sr_widget.onDemand .crypto .live_stock .lb-icon{8px 6px 5px 3px !important} #sr_widget.crypto.onDemand a.text{border-bottom:1px solid #ccc;padding-bottom:5px;display:block;width:100%} #sr_widget.onDemand .sr_desc .text p, #stock_pro.onDemand .sr_desc .text p{font-size:12px;font-weight:400;}
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This year’s ranking has seen some churning, with ELSS funds climbing to the top position, thanks largely to the market correction in the past three months. The NPS has slipped to second position, while Ulips have maintained their place in the ranking. Especially noteworthy are retirement schemes of mutual funds, which have climbed two rungs from the sixth place in 2024 to the fourth position. These hybrid funds are safer bets in volatile markets, but don’t get the favourable tax treatment that Ulips, NPS and even ELSS funds enjoy.
Traditional insurance policies have maintained their position at the bottom of the ranking. Though life insurance is critical in any financial plan, these traditional policies offer neither good returns, nor adequate cover.
We hope our cover story will help taxpayers choose tax-saving instruments that serve a purpose in their financial plans.
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ELSS funds
RETURNS (Past five years): 19.39%
LOCK-IN: 3 years
The correction in the market has made these funds more attractive. Going forward, large-cap oriented funds will do well. ELSS funds are back in the reckoning. Apart from their potential to give high returns, they score high on other parameters. They are transparent, offer a high degree of flexibility, have very low charges, and also the shortest lock-in period of just three years among all tax-saving options.
ELSS funds not only save tax for investors, but also generate tax-free gains. Long-term capital gains from equity funds are now taxable, and last year’s Budget increased it from 10% to 12.5%. But it also increased the tax-free exemption from Rs.1 lakh to Rs.1.25 lakh. Regular harvesting of gains can reduce the liability to a great extent.
Best ELSS funds
These funds saved tax and created tax-free wealth for investors.Not all ELSS funds carry the same risks. Some allocate more to riskier small- and mid-cap stocks. The best performing ELSS fund, Motilal Oswal ELSS Tax Saver, for instance, has more than 50% of its portfolio in mid-cap and small-cap stocks. The other four funds in our list have allocated more than 75% of their portfolio to large-cap stocks. Go for a fund that aligns with your risk appetite.
Volatility is inherent to stocks. Equity markets were volatile in 2024 and analysts have warned of several headwinds in the coming months. Besides the heightened geopolitical risks, there are fears of a global recession, persistent inflation, weakening demand and lower corporate earnings.
This is why it is best to invest in these schemes through monthly SIPs. However, a staggered approach may not be possible for taxpayers who need to submit the proof of tax-saving investments to their employers within the next few days. They will have to choose between taking high risk by investing a large sum in these equity funds right away, or paying a higher tax for now and claiming a refund later after completing their SIPs before the financial year ends on 31 March. Some taxpayers might want to take the middle road by putting some amount in ELSS funds and the rest in safer tax-saving options.
NPS
RETURNS (Past five years): 7.5-16.9%
LOCK-IN: Till retirement
Besides the additional deduction, changes in tax rules have made the NPS more attractive for investors. The NPS has slipped to the second place, but is still a very good way to save tax. The scheme offers a triad of tax-saving opportunities. Firstly, contributions up to Rs.1.5 lakh qualify for deduction under the overarching Section 80C. Secondly, an additional deduction of up to Rs.50,000 can be availed of under Section 80CCD(1B). Thirdly, employer contributions of up to 10% of the basic salary in the NPS are exempt from taxation. This year’s Budget has increased this limit to 14% of the basic salary for those opting for the new tax regime.
NPS funds have done very well
“The taxpayers who are not using the additional deduction through the NPS are missing out on a great opportunity to save tax and build a retirement kitty,” asserts Sudhir Kaushik, CEO of TaxSpanner.com.
While equity funds of the NPS have given terrific returns in the past (see table), the outcome in 2025 could be different. The outlook for the bond market is more optimistic than the prospects of the stock market. The 10-year government bond yield has risen more than 20 basis points from 6.68% to 6.91% in the past month. However, analysts expect the RBI to cut rates in February and interest rates are likely to enter a downward trajectory. As the rate cycle reverses, corporate bond funds and gilt funds of the NPS could generate decent returns. Keep in mind that NPS investors can rejig their asset mix up to four times a year. There is no tax implication for such a switch.
Retirement mutual funds
RETURNS (Past five years): 9-19% LOCK-IN: 5 years
The high returns from these plans look attractive but the taxability of returns is a damper. Unlike the ELSS funds that invest almost their entire corpus in equities, retirement mutual funds are hybrid schemes that invest in a mix of debt securities and equities. Except for the HDFC Retirement Savings Equity Fund, which has about 47% in stocks, all the other schemes have allocated less than 40% of their corpus to equities. The Nippon India Retirement Fund is playing it very safe, with only 20% in equities. This conservative allocation has led to the scheme delivering lower returns in the past few years, but could prove helpful in case the markets decline.
How retirement funds performed
Most funds have only 20-40% of their corpus allocated to equities.These retirement funds suit low-risk investors who want to save for the long term, but seek better returns than fixed deposits and small savings schemes. Watch out when you invest in such funds. Many retirement schemes with a lock-in period of five years are not eligible for tax deduction under Section 80C.
Ulips
RETURNS (Past five years): 7-18%LOCK-IN: 5 years
Though not as flexible as ELSS funds, these insurance-cum-investment plans are more tax-efficient. Ulips gained favour after the introduction of taxation on long-term capital gains from equities and equity-oriented mutual funds, and the removal of the indexation benefit from non-equity funds. The income from Ulips remains entirely tax-exempt under Section 10(10D) if the life cover is at least 10 times the annual premium and the premium from all Ulips bought after 1 February 2021 is up to Rs.2.5 lakh a year.
The new Ulips from insurance companies have very low cost structures, making them almost as cheap as the direct plans of mutual funds. Unlike the NPS, they allow periodic withdrawals subject to certain conditions.
Ulips have other tax advantages too. They allow investors the flexibility to allocate funds across equity, debt and liquid asset classes. The gains from shifting between these asset classes within a Ulip are not subject to tax. This makes Ulips an effective portfolio rebalancing tool as also a one-stop fund for retirement planning that can generate tax-free income in retirement.
However, there are certain drawbacks as well. It is a multi-year commitment and a policyholder must continue paying the premium for the full term. Premature closure of the plan is allowed, but leads to losses or locks up the funds for very long periods. Policyholders also cannot shift to another insurer in case their Ulip funds are not doing too well.
Though Ulips are no longer toxic investment products, they continue to be missold, especially during the tax-planning season. Buyers should assess their requirements carefully before signing up.
Sukanya Yojana
RETURNS (Jan-Mar 2025): 8.2%LOCK-IN: Till child is 18
Open only to parents with girls below 10, this is a good way to build a tax-free corpus for the child’s goals.
The spread of the tax net has made instruments such as the Sukanya Samriddhi Yojana very attractive. The interest rates of small savings schemes were kept unchanged for this quarter, which is disappointing. Even so, the 8.2% interest offered by the scheme is not only higher than that provided by banks and other small savings schemes, but also tax-free.
However, there are certain limitations. The scheme is open only to taxpayers with daughters below 10 years. The account is opened in the name of the child and the maturity proceeds have to be used for her education and marriage. There is also an annual cap of Rs.1.5 lakh on the investment. A parent can open an account for a maximum of two daughters, but the combined investment in the two accounts cannot exceed Rs.1.5 lakh in a year. Accounts can be opened in any post office or designated banks with a minimum investment of Rs.1,000.
Keep in mind that the interest rates of small savings schemes are linked to the government bond yields and reviewed every quarter. The rates have remained unchanged for more than two years despite a consistent fall in bond yields.
What’s more, the interest rate cycle is poised to change and bond yields could fall if the RBI decides to cut rates in the coming months. So investors should factor in the possibility of a lower rate of interest from the Sukanya scheme in the coming years.
Pension plans
RETURNS (Past five years): 7-16% LOCK-IN:Till retirement
Pension plans from insurance companies can’t match the NPS in costs, flexibility and tax benefits. There are very few reasons to invest in a pension plan from an insurance company. These pension schemes are not eligible for the additional deduction of Rs.50,000 that the NPS enjoys. The NPS also offers greater flexibility. The investor can shift from one pension fund manager to another if he is not satisfied with the service or the performance of the funds. In case of a pension plan, the investor is tied to the company till the plan matures. NPS investors can continue to remain invested even after retirement and withdraw funds through systematic withdrawal plans.
Pension plans also don’t provide assured returns like the PPF or Provident Fund, but in the long term, they can deliver higher returns than these fixed-income oriented instruments. As in Ulips, pension plans allow investors to change their asset mix. A 10-15% sliver of equity exposure can deliver inflation-beating returns in the long term.
The insurance industry has been clamouring for a level playing field in the pension space but successive Budgets have not listened to their demands. It is unlikely that the coming Budget will extend to them the exclusive tax benefit enjoyed by the government-sponsored NPS.
Sr Citizens’ Savings Scheme
RETURNS ( Jan-Mar 2025 ): 8.2%LOCK-IN: 5 years
With no change in the interest rate, this scheme remains the best tax-saving option for senior citizens.
The Senior Citizens’ Savings Scheme (SCSS) is the best investment option for those above 60. Though the interest earned is fully taxable as income, senior citizens enjoy tax exemption for interest up to Rs.50,000. This means up to Rs.6.25 lakh invested in the scheme will earn taxfree interest.
The scheme pays out pension at the start of each quarter. At 8.2%, it offers a higher return than the PPF. Banks offer higher rates to senior citizens for five-year tax-saving fixed deposits, but they cannot match the SCSS. The investment limit per individual was hiked from Rs.15 lakh to Rs.30 lakh two years ago.
The scheme scores low in our ranking because it is open only to those above 60. In some cases, where the investor has opted for voluntary retirement and has not taken up another job, the minimum age is relaxed to 58 years. There is also no age bar for defence personnel. They can invest in the scheme even before 60 as long as they satisfy the other requirements.
An account can be opened in a post office or at designated branches of banks. It is better to open an account with a bank because operating it will be less cumbersome.
PPF
RETURNS (Jan-Mar 2024): 7.1% LOCK-IN: 15 years from inception
Tax-free interest makes this more attractive than bank deposits, but watch out for the extremely long lock-in period.
The PPF offers assured and tax-free returns, but still scores low in our ranking. That’s because experts believe the interest rate cycle is poised to turn. They expect the RBI to cut interest rates in February. When that happens, government bond yields will move down. Since the interest rates of small savings schemes are linked to government bond yields, their rates would also decline. When government bond yields rose during the past two years, the interest rates of small savings schemes remained unchanged. Howver, when bonds yields will come down, rates are likely to be reduced. The PPF rate could remain at the same level if not below 7%.
At the same time, the 7.1% offered by the PPF is higher than that offered by most banks. High-income earners, who used to put large amounts in the Provident Fund before the government put an annual `2.5 lakh cap on the tax-free investment, will find it particularly useful.
A PPF account can be opened in a post office branch or designated branches of PSU banks. Some private banks, such as HDFC Bank and ICICI Bank, also offer the facility to invest in the PPF.
Though PPF is for 15 years, it does not lock up your money for that long. The 15-year term is from the day of opening the account and the lock-in progressively reduces. In the 14th year, it is only one year. If you opened your PPF account in 2011, the lock-in period will end next year.
NSCs, tax-saving FDs
RETURNS: 7.25-8%LOCK-IN: 5 years
Suits people who are in a rush and senior citizens who have exhausted the investment limit in SCSS.
The 7.25-7.5% offered by tax-saving fixed deposits might look attractive, but tax will reduce the effective yield. Keep in mind that interest earned on fixed deposits is fully taxable at the slab rate, so the post-tax return in the 30% tax bracket is less than 5%. However, tax-saving deposits offer a high degree of investment ease. Just log on to your Net banking account, and a few clicks of the mouse will complete the process. Even if the bank is closed or you are travelling, you can invest using Net banking.
Top tax-saving fixed income options
NSCs offer a higher rate than bank deposits. What’s more, the interest earned on the NSC is eligible for deduction under Section 80C in the following years. If you buy Rs.50,000 worth of NSCs in January 2025, one year later, the investment would have earned an interest of Rs.3,850. You can claim deduction for this Rs.3,850 for the year 2025-26. The following year, the investment would earn about Rs.4,150 in interest. This can be claimed as a deduction in 2026-27.
Life insurance policies
RETURNS: 5-6% LOCK-IN: Till maturity
Traditional insurance plans are the worst way to save tax. The corpus is tax-free, but flexibility and returns are very low. Life insurance is important because it safeguards all other financial goals of the investor. An individual should ideally have a life insurance cover of roughly 8-10 times his annual income. Large outstanding loans should also be covered. Traditional life insurance policies fall between two stools because they neither give high returns, not offer adequate life cover to the buyer.
If you are looking for a life insurance cover, the purpose is best served through a pure protection term plan that has no investment component. Term plans cost a fraction of what you will pay for a traditional endowment policy or a money-back plan. A 30-year-old man can buy a cover of Rs.1 crore for 30 years by paying an annual premium of Rs.9,000-10,000 per year.
In comparison, an endowment plan offering a cover of Rs.40-50 lakh will cost him almost Rs.4-5 lakh per year. These traditional insurance policies suit high-net worth investors looking for guaranteed returns and tax-free maturity corpus. Small taxpayers looking for tax deduction under Section 80C should avoid these.
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This story originally appeared on: India Times - Author:Faqs of Insurances
