Few days back a good friend of mine Ronak raised an important question…. why to save tax by investing in 80 C instruments where the rate of return is such that it hardly beats the inflation rate !!! Why not pay tax & invest the same amount where you can get a higher rate of return.
At some point of time almost all us of think about it. Let’s discuss whether you should invest in 80 C instrument & save tax or invest in some highly risky asset class in order to get higher rate of return over a period of time.
In case your income for a financial year 2012-13 (1st April – 31st March) is above Rs.2 lakh, you need to pay tax to government on income above Rs.2,00,000. Click to read an Article on How to Calculate Tax.
Now government says that over & above Rs.2,00,000, you can save tax on Rs.1,00,000 by investing in 80 C instruments. The Big question is should you invest here!!!…let’s see what to do with Rs.1,00,000:
Case1 : You decide to invest in 80 C tax saving instruments. Tax saved in accordance with your tax bracket will be;
|TAX BRACKET||TAX SAVED (Rs.)|
In case you invest Rs.1,00,000 in 5 year National Saving Certificate, amount after 5 years will be Rs.1,52,350.
Case 2: You decide to pay tax and invest the the remaining amount out of Rs.1,00,000 at some other place where you will get a higher rate of interest. Remember that after paying tax you will be left with a lesser amount to invest.
|TAX BRACKET||TAX (Rs.)||AMOUNT LEFT AFTER PAYING TAX (Rs.)|
Ok , so the point is….if you are able to invest the money left after paying the tax at a place where interest rate are higher than tax saving instruments, go for it, else it’s better to save money in tax saving instrument.
Also in case you decide to pay tax, actual amount invested in some other instrument will be lower than the amount invested in tax saving instrument because of deduction of tax as per your tax bracket.
In case you invest Rs.1,00,000 in 5 year National Saving Certificate, amount after 5 years will be Rs.1,52,350. You should at least get this much amount in case you are not investing in tax saving instrument such as NSC. (For the Financial Year 2012-13, NSC rate of return for 5 year duration is 8.6% compounded half yearly)
Here tenure for investment is taken as 5 years because LOCK IN period for NSC is 5 years. The table shows how much rate of return one should get from their investment to break even the return which they will get from investing in tax saving instruments;
|INVESTMENT RATE OF RETURN|
If you fall in 10 % tax bracket & you decide not to invest in tax saving instrument, you have to pay Rs.10,000 as tax out of Rs.1,00,000. Now the remaining Rs.90,000 need to be invested at 11% to get the amount similar to that by investing in a 5 year National Saving Certificate.
Note: It’s hard to find a place where you will get assured 11% rate of return 🙁
Similarly break even for 20% tax bracket is when you invest @ 14% & for 30%, it’s 17%.
Conclusion: Though rate of interest in tax saving instruments such as NSC, PPF etc. is not so high, but it’s after tax rate of return is quite impressive. So it’s highly recommended that you save tax by investing in tax saving instruments rather than paying tax & investing the after tax amount in some risky asset.