Appraisals bring cheers to salaried individuals as they get more money in hands to spend more and get some relief amid high rate of inflation. However, along with getting more money to spend, you have to pay more tax also, if all the available tax-saving avenues are not explored.
So, to avoid paying more taxes due to the hike in salary, you should invest in tax-saving instruments first.
Archit Gupta – Founder and CEO Clear, lists the following tax-saving options that you may consider:
If you have a salary hike, you must pick suitable investments to save taxes based on your risk tolerance. One can opt for the National Pension System (NPS), which offers an additional tax deduction over and above the Rs 1.5 Lakh per year under Section 80C. It is a government-backed retirement savings scheme which offers asset classes such as equity, government securities, corporate debt and alternative investment funds.
NPS offers two different accounts, Tier I and Tier II. One must mandatorily open a Tier I account to invest in the NPS. Tier II is a voluntary account. Investors can choose asset classes based on their risk profile. However, NPS caps equity investments at 75 per cent.
NPS offers a tax deduction of up to Rs 50,000 per financial year under Section 80CCD(1B) of the IT Act. Moreover, one can claim up to 10 per cent of their salary (Basic Salary + Dearness Allowance) if the employer contributes to the NPS in the employee’s name.
Suppose you fall in the taxable bracket after a salary hike. Based on your risk profile, you must choose investments that qualify for the Section 80C tax deduction. For instance, conservative investors can invest in the Public Provident Fund (PPF) or the National Savings Certificate, which offer higher interest rates than bank FDs.
PPF qualifies for the EEE (exempt-exempt-exempt) tax regime where investments up to Rs 1.5 Lakh per year qualify for the Section 80C tax deduction. Moreover, interest and amount withdrawn at maturity are tax-free.
In the case of National Savings Certificate (NSC), the interest earned is not paid out to investors but gets reinvested and accumulated. The interest on NSC during the first four years of the investment qualifies for the Section 80C tax deduction as its reinvested. However, the NSC interest in the fifth year at maturity is taxed according to your income tax bracket.
Every quarter, the government revises the interest rates on small savings schemes like PPF and NSC. PPF currently offers an interest rate of 7.1 per cent and NSC an interest rate of 6.8 per cent for the April to June 2022 quarter. However, the government may hike interest rates soon.
Aggressive investors can look at Equity Linked Saving Schemes (ELSS), which invest predominantly in equity and equity-linked instruments. It has a three year lock-in period and qualifies for the Section 80C tax deduction.
One can invest in ELSS through the Systematic Investment Plan (SIP). It is a facility offered by AMCs where you invest specific amounts of money regularly over time. SIP helps one average out the unit’s purchase price, called Rupee Cost Averaging and avoid timing the equity market. Moreover, long term capital gains (LTCG) from ELSS up to Rs 1 Lakh are tax-free. One must pay a 10 per cent tax on LTCG from ELSS above Rs 1 Lakh.
Salaried employees can opt to invest in the Voluntary Provident Fund (VPF) in addition to the mandatory Employee’s Provident Fund (EPF) contributions. It is a safe investment option, and the contribution qualifies for the Section 80C tax deduction. VPF currently offers an interest rate of 8.1 per cent for FY 2021-22, which is one of the highest among fixed-income investments. You can contribute up to 100 per cent of your basic salary and dearness allowance towards the VPF. However, you cannot discontinue contributions before the base tenure of five years.
Interest received on contributions to EPF or VPF exceeding Rs 2.5 lakh during the financial year is taxable at the applicable tax slab rates. Only an employee’s contribution should be considered for the threshold limit of Rs 2.5 lakh. Also, the PF department shall deduct TDS at 10 per cent on the interest credited.