The tax season arrives each year. In this season, salaried and self-employed professionals look into the types of income tax returns and how much tax they have to pay. At the same time, they also look for instruments and methods they can use to save tax. While the main goal remains tax saving, how you do it is also of great importance. You have to make sure that you understand the returns or maturity amount of the financial instrument that would get you tax savings.
The idea is to earn tax deductions and other benefits by putting money into the right financial instruments. These financial instruments earn you income and you have to see that this income is not taxable or less taxable. Otherwise, the income you earn ends up being used for tax itself. The best way to choose the right investment tool to save tax is to look at its tax status.
Types of tax status
Investment instruments that help you save tax have one of the following tax statuses:
- EEE – Exempt, Exempt, Exempt
This tax status has three sections that mention the word ‘exempt’. Each of these sections apply to different parts of the investment instrument. This particular tax status has all three of the sections exempt from tax. The first exempt signifies that the contribution you make towards the investment instrument is non-taxable. The second exempt stands for the returns being tax-free. The third ‘exempt’ means, the payout you would receive from this opportunity is tax-free when the instrument reaches maturity.
- EET – Exempt, Exempt, Taxable
Just as the class above, the different parts of the category’s nomenclature refer to different parts of the investment instrument. The first ‘exempt’ shows that the money you put into the investment instrument is exempt from taxable income. The second part that reads ‘exempt’ refers to the returns of the instrument being tax-free. However, the last part of this class has ‘taxable. This means that the payout you would receive from the investment opportunity upon maturity would be taxable.
- ETT – Exempt, Taxable, Taxable
The logic of what each of the three terms in this category mean remains the same. As per that logic, the amount you invest in the investment opportunity remains exempt from tax. However, that is all that remains similar from the earlier categories. Both the returns you gain during the investment and the final payout at the time of maturity will be taken as taxable income.
Investment opportunities to save tax
As per the Income Tax Act, 1961, tax deductions can be claimed through the Section 80C of the act. Hence, it is important to look at investment opportunities that are connected to this particular section. Some of them are:
- Equity Linked Saving Schemes
Abbreviated as ELSS, these schemes are essentially mutual funds of the equity kind. These funds invest in stocks and other similar investment avenues. ELSS schemes usually have a lock-in period of around three years. As far as the returns are concerned, they are known to generate returns that end up beating inflation for your personal finances.
Life insurance is often considered as a product of financial security. However, there is much more to the product than simply life coverage. A big part of the appeal of life insurance for buyers is the tax deductions it can offer. Moreover, many other types of life insurance policies offer more than life coverage. For example, Unit-linked insurance plans or ULIPs give policyholders the extra benefit of wealth creation through investment into market instruments. This benefit is offered in addition to the life coverage that involves a death benefit for the family of the policyholder. Also, ULIPs have a maturity benefit. Perhaps, the best part of ULIPs is that they fall into the EEE tax status.