For many of us tax saving is usually a once in year investment exercise to save up to Rs 46,350 in taxes under Section 80C of Income Tax Act 1961. However, tax saving investments can also help you meet your long term financial goals like retirement planning. If you look at the various investment options under Section 80C, you can find that many of these investments can serve your retirement planning needs in addition to saving taxes. Employee provident fund, public provident fund (PPF), life insurance policies, National Pension Scheme (NPS) and mutual fund Equity Linked Savings Schemes (ELSS Mutual Funds) are all investments in Section 80C that are in some ways or other associated with long term financial planning, including your retirement.
Unfortunately in India, retirement planning is not given the due importance that it deserves. Over the years, employee provident fund, public provident fund and traditional life insurance policies have been the investment options commonly associated with retirement planning of Indians as these are perceived as risk free investments. But is it sufficient to meet your retirement needs. Let us see through an example –
Mohan aged 30, invests Rs 12,500 per month in a mix of PPF, EPF and life insurance policies assuming overall average annual return of 7.50%. At retirement, when Mohan is aged 60, he can accumulate Rs 1.69 Crores.
The amount may look impressive, but how long will this amount last after your retirement? Assuming 6% annual inflation you get only 1.5% real return. Therefore, it does not look that impressive any more post inflation. The simple point is that while you are working you have income from your profession, you have certain lifestyle and other financial commitments and you can save only a small 0portion of your income. And this small portion of saving is not adequate to meet your retirement life needs unless it earns much more than what Mohan is currently earning on his investments.
So what is the solution?
The solution lies in getting better returns than average of 7.5% on your investments and that is the crux of having a good retirement planning. If instead of 7.5% returns, suppose Mohan gets 12% average returns on his investments, then he can create a corpus of an amazing Rs 4.42 Crores which is more than 2.5 times of what he can get from the average return of 7.5% on traditional his tax saving investments.
Is it possible to get 12% return on your investment with tax saving?
The answer is yes – ELSS Mutual Fund has given excellent returns over the long term. SIPs in top performing ELSS Mutual funds have given around 20% or more compounded annual returns (based on the current NAV) in the last 15 to 20 years. However, you should note that investments in ELSS mutual funds are subject to market risks.
The last 10 year period in equity markets included three bear markets, in 2008, in 2011 and in 2015 – 2016. Therefore, the last 10 years, by no means, represent a dream run for equities. However, even in the last 10 years, monthly SIPs in top performing ELSS funds gave nearly 15% returns, despite the challenging market and economic conditions.
The performance of ELSS Mutual Funds over the last 10 years validates the fact that, equity is the best asset class to create wealth in the long term for meeting your retirement or long term investment needs over and above savings taxes for you.
Equity Linked Savings Scheme (ELSS)
ELSS Mutual Funds or Equity Linked Savings Schemes (ELSS) is an equity oriented scheme that qualifies for tax savings under Section 80C up to a limit of Rs 150,000 per annum. ELSS is essentially a diversified equity scheme with a lock in period of three years from the date of the investment.
Long term capital gains in ELSS are tax exempt. Dividends paid by ELSS are also tax free in the hands of the investor. If you invest in an ELSS Mutual Funds through systematic investment plan (SIP), each investment will be locked in for 3 years from their respective investment dates.
Compared to other traditional tax saving investments under Section 80C, ELSS offers higher liquidity and potentially superior post tax returns as we have seen above. However, as with all mutual fund investments ELSS are also subject to market risk. However, even if we take the average or ELSS top performing scheme returns, they are much higher than that of the returns of any risk free 80C investment options.
Equity is undoubtedly the most desirable asset class for the investors. As such ELSS is one of the best investment options for savings taxes under Section 80C of the Income Tax Act as well as for retirement planning. Investors with adequate risk taking ability can choose ELSS Mutual funds for their tax saving needs and retirement planning. Investors who are not ready to take much risk may allocate a percentage of their tax saving investments into ELSS mutual funds and rest in traditional investments to enjoy the best of both the worlds.