Section 80C, tax planning and investments

Learning how to plan your taxes is a major part of choosing an investment strategy. In this article we will look at Section 80C, one of the most important provisions for investors in the tax laws.

What is Section 80C?

The government, in order to encourage savings, gives tax breaks to certain financial products as discussed in Section 80C of the Income Tax Act. These investments are often referred to as 80C investments.

Up to a limit of Rs 1 lakh, the money that you invest in these products is deduc
tible which means that you don't have to pay income tax on it. Thus if you are in the 30 per cent tax bracket and you invest the maximum allowed you save Rs 30,000 in taxes.

Small savings schemes

These include the public provident fund (PPF) and National Savings Certificate (NSC). They offer a return of around 8 to 8.5 per cent which is quite low compared to typical returns in equity products. Furthermore, there is a relatively long lock-in period, 15 years for the PPF and 6 years for the NSC. Their main advantage is that they offer a guaranteed return unlike equity-based products.

Equity linked savings schemes

These are basically mutual funds which are specially created to provide tax benefits. As with regular mutual funds there is no guaranteed return and you can lose money in a period of falling stock prices as has happened in the first half of 2008. However, ELSS usually provides a higher return than small savings schemes and also a lower lock-in period of three years.

Examples of ELSS include Franklin India Taxshield and HDFC [Get Quote] Taxsaver. As with regular mutual funds, these schemes pursue a range of investment strategies: For instance, some may focus on large cap stocks while others may focus on small and mid cap stocks. It makes sense to invest in more than one scheme to diversify some of your risk.

Making a choice

How do you decide to allocate your Rs 1 lakh 80C limit? This will depend on your other financial decisions; for example whether you have taken a home loan or purchased life insurance. As to the decision between small savings schemes and ELSS two of the most important factors are your attitude to risk and inflation.