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Saving Income Tax – Understanding Section 80C Deductions

This article explains how the deductions under Sec 80C of the Income Tax (IT) Act can help reduce your income tax liability. It also helps you decide where to invest to claim deductions under Sec 80C.

The income we earn is subject to income tax by the government. The rate of income tax is different for different income levels, and thus, the income tax that you pay depends on your total earnings in a given year.

(To know more about the income tax slabs for FY 08-09 and how they put more money in your pocket, please read “Income Tax (IT) Slabs / Brackets – FY 2008-09 AY 2009-10”)

 

Section 80C – The Basics

The government encourages certain types of savings – mostly, long term savings for your retirement – and therefore, offers you tax breaks on such savings.

Sec 80C of the Income Tax Act is the section that deals with these tax breaks. It states that qualifying investments, up to a maximum of Rs. 1 Lakh, are deductible from your income. This means that your income gets reduced by this investment amount (up to Rs. 1 Lakh), and you end up paying no tax on it at all!

(Section 80C investment is just one of the many avenues of saving income tax! Please read “Reached Section 80C limit? You can still save more income tax!” for more)

This benefit is available to everyone, irrespective of their income levels. Thus, if you are in the highest tax bracket of 30%, and you invest the full Rs. 1 Lakh, you save tax of Rs. 30,000. Isn’t this great? (Illustrative example and downloadable spreadsheet follow later in the article)

So, let’s understand the qualifying investments first.

 

Qualifying Investments

Provident Fund (PF)

The payments that you make to your PF are counted towards Sec 80C investments. For most of you who are salaried, this amount gets automatically deducted from your salary every month.Thus, it’s not just compulsory savings for your future, but also immediate tax savings!

Voluntary Provident Fund (VPF)

If you increase your PF contribution over and above the statutory limit (as deducted compulsorily by your employer), even this amount qualifies for deduction under section 80C.

Public Provident Fund (PPF)

If you have a PPF account, and invest in it, that amount can be included in Sec 80C deduction. The minimum and maximum allowed investments in PPF are Rs. 500 and Rs. 70,000 per year respectively.

To learn more about PPF, please read “Public Provident Fund (PPF) – Plan Your Retirement and Save Tax”.

Life Insurance Premiums

Any amount that you pay towards life insurance premium for yourself, your spouse or your children can also be included in Section 80C deduction.

Please note that life insurance premium paid by you for your parents (father / mother / both) or your in-laws is not eligible for deduction under section 80C.

If you are paying premium for more than one insurance policy, all the premiums can be included.

It is not necessary to have the insurance policy from Life Insurance Corporation (LIC) – even insurance bought from private players can be considered here.

Equity Linked Savings Scheme (ELSS)

There are some mutual fund (MF) schemes specially created for offering you tax savings, and these are called Equity Linked Savings Scheme, or ELSS. The investments that you make in ELSS are eligible for deduction under Sec 80C.

To know the multiple benefits of Equity Linked Savings Scheme (ELSS), please read “ELSS is not for someone else”.

Home Loan Principal Repayment

The Equated Monthly Installment (EMI) that you pay every month to repay your home loan consists of two components – Principal and Interest.

The principal component of the EMI qualifies for deduction under Sec 80C.

Click here to download a spreadsheet that can be used to find the principal and interest components of your EMI.

(You need to be logged-in to download the spreadsheet. For free registration that takes less than a minute, please click here)

Even the interest component can save you significant income tax – but that would be under Section 24 of the Income Tax Act. Please read “Income Tax (IT) Benefits of a Home Loan / Housing Loan / Mortgage”, which presents a full analysis of how you can save income tax through a home loan.

Stamp Duty and Registration Charges for a home

The amount you pay as stamp duty when you buy a house, and the amount you pay for the registration of the documents of the house can be claimed as deduction under section 80C in the year of purchase of the house.

National Savings Certificate (NSC)

The amount that you invest in National Savings Certificate (NSC) can be included in Sec 80C deductions.

Infrastructure Bonds

These are also popularly called Infra Bonds. These are issued by infrastructure companies, and not the government. The amount that you invest in these bonds can also be included in Sec 80C deductions.

Pension Funds – Section 80CCC

This section – Sec 80CCC – stipulates that an investment in pension funds is eligible for deduction from your income. Section 80CCC investment limit is clubbed with the limit of Section 80C – it maeans that the total deduction available for 80CCC and 80C is Rs. 1 Lakh.

This also means that your investment in pension funds upto Rs. 1 Lakh can be claimed as deduction u/s 80CCC. However, as mentioned earlier, the total deduction u/s 80C and 80CCC can not exceed Rs. 1 Lakh.

Bank Fixed Deposits

This is a newly introduced investment class under Section 80C. Bank fixed deposits (also called term deposits) having a maturity of 5 years or more can be included in your Sec 80C investment.

(Please read “Fixed Deposits (FD) for saving income tax through section 80C” for more on this)

Senior Citizen Savings Scheme (SCSS)

SCSS is a deposit scheme specially meant for elderly citizens.

(Please read “All you wanted to know about Senior Citizen Savings Scheme (SCSS)” for more on this)

Post Office Time Deposit Account

This is the fixed / term deposits offered by the Department of Posts (Government of India) through the post offices in India.

If the time deposit is opened for a duration of 5 years or more, the amount invested is qualified for deduction under section 80C.

(Please read “Post Office Time Deposit Account (Fixed / Term Deposit)” for more on this)

Others

Apart form the major avenues listed above, there are some other things, like children’s education expense (for which you need receipts), that can be claimed as deductions under Sec 80C.

 

Example

Login Required Download the spreadsheet containing the calculations for this example and other illustrative examples

Let’s say you are a male with an income of Rs. 2,50,000 for the year.

Your employer has deducted Rs. 24,000 as PF. You have no housing loan, but have purchased NSC worth Rs. 10,000.

Thus, your total qualifying investments under Sec 80C are Rs. 34,000. Since this is less than Rs. 1 Lakh, this is the amount that would get deducted from your income. Thus, you would have to pay tax on Rs. 2,16,000.

The tax on Rs. 2,16,000 would be Rs. 17,200. If there were no investments made under section 80C, the tax on an income of Rs. 2,50,000 would have been Rs. 24,000. Thus, by making these investments, you end up saving Rs. 6,800!

Also, if you would have made the full investment of Rs. 1,00,000, the tax would have further reduced to Rs. 4,000 – a saving of Rs. 20,000!

Login Required Download the spreadsheet containing the calculations for this example and other illustrative examples

 

So, where should you invest?

Like most other things in personal finance, the answer varies from person to person. But the following can be the broad principles:

Provident Fund: This is deducted compulsorily, and there is no running away from it! So, this has to be the first. Also, apart from saving tax now, it builds a long term, tax-free retirement corpus for you.

Home Loan Principal: If you are paying the EMI for a home loan, this one is automatic too! So, it comes as a close second.

Life Insurance Premiums: Every earning person having dependents should have adequate life insurance coverage. (For more on this, please read “Life after life – Why you should buy Life Insurance”) Therefore, life insurance premium payments are the next.

Voluntary Provident Fund (VPF) / Public Provident Fund (PPF): If you think that the PF being deducted from your salary is not enough, you should invest some more in VPF, or in PPF.

Equity Linked Savings Scheme (ELSS): After the above, if you have not reached the limit of Rs. 1,00,000, then you should invest the remaining amount in Equity Linked Savings Scheme (ELSS).

Equities provide the best, inflation-beating return in the long term, and should be a part of everyone’s portfolio. After all, what can be better than something that gives great return and helps save tax at the same time?

To read more about Equity Linked Savings Scheme (ELSS), please read “ELSS is not for someone else”.

 

When to Invest?

Many of us start looking for investment avenues only in February or March, just before the Financial Year is getting over.

(To understand terms like Financial Year, Assessment Year, and Previous Year better, please read “Income Tax (IT) Jargon – Financial Year (FY), Assessment Year (AY) and Previous Year (PY)”)

This is a big mistake! One, you would end up investing your money without putting proper thought to it. And secondly, you would end up losing the interest / appreciation for the whole year!

Instead, decide where you want to make the investments, and start investing right from the beginning of the financial year – from April. This way, you would not only make informed decisions, but would also earn the interest for the full year from April to March!

Happy tax planning!

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