Investments That Give Tax-Free Income

By Kavya Balaji | January 21, 2019

 Tired of paying taxes on income from investments? Then, you should consider at least one investment from this list. 

Investments That Give Tax-Free Income

You make investments like Fixed Deposits (FDs) to earn reasonable returns. However, you don’t feel great when taxes eat away those returns, right? This is especially true for those in the 30% tax bracket. There is also Tax Deducted at Source (TDS) if your interest income exceeds Rs. 10,000 in a financial year.  

Consider this: the post-tax return for a 9% FD will be only 8.07% if you are in the 10% tax bracket. For those in 20% tax bracket, it will work out to 7.14% and if you are in the highest tax bracket, you will get just 6.21%! Even if you choose a tax-saver Fixed Deposit, you need to pay taxes on the interest income. Is there a way out? Of course! Here are investments that will give you tax-free income: 

Public Provident Fund (PPF) 

Started by the National Savings Organisation and promoted by the Government of India, PPF is a long-term (read 15 years) investment that you can use for goals such as your child’s education or your retirement. This investment falls under the Exempt-Exempt-Exempt (EEE) category.

This means the investment you make, the income you will earn, and the maturity proceeds are totally tax-free. You can also claim tax benefits under Section 80C of the Income Tax Act for the amount that you invest. 

The minimum investment for PPF is just Rs. 500. You can invest up to Rs. 1,50,000 for a financial year. The Central Government fixes the interest rate for PPF along with rates for other savings schemes and the rates are revised every quarter.

Why is that?

Now, all savings schemes offered by the Department of Posts are linked to government securities’ prices. Since government securities are traded every day, their prices change constantly. However, savings schemes cannot be made volatile. Therefore, the rates are reset every quarter. The interest rate for PPF this quarter is 8%.  

Since the interest for your PPF account is compounded annually and the interest is tax-free, the effective yield on your investment will be much higher. If you are in the 30% tax bracket, the effective yield for your 8% PPF will be a good 11.6%.  

Additional Reading: All About The Public Provident Fund (PPF) Scheme 

PPF interest is credited on 31st of March every year.  How is the interest calculated? The lowest balance between the 5th of any month and the last day of that month will be used to calculate the interest on your PPF account. So, make sure you put the money in your PPF account by the 5th of every month.  

Did you know? Your PPF account cannot be used by debtors to claim your loan dues. It cannot be attached by a court for resolving your liabilities. 

Employee Provident Fund (EPF) 

Just like PPF, EPF also enjoys the EEE status. This is only if you withdraw the money after retirement, of course! Premature withdrawal is tax-free if you have held the EPF account for 5 continuous years. The interest amount will also be tax-free. You can claim tax deductions under Section 80C for the amount invested.  

You have to compulsorily contribute 12% of your basic salary towards EPF while your employer will contribute equally. EPF covers every company that employs 20 or more persons and the rate applicable for these companies is 12%. However, EPF rules state that certain organisations that employ less than 20 persons can contribute 10% under certain conditions and exemptions.  

You can also make voluntary contributions over and above this amount. How much can you contribute? You could invest up to 100% of your basic salary plus your dearness allowance in your EPF. All contributions that you make will earn interest at the same rate. The tax and withdrawal rules for these voluntary contributions will also be the same.  

Additional Reading: Now Withdraw 90% Of EPF To Buy A Home 

Note that 8.33% of the employer’s contribution will be towards the Employees’ Pension Scheme (EPS). For every employee whose basic pay is Rs. 15,000 or more, Rs 1,250 will be invested in EPS. If the basic pay is less than Rs. 15,000, then 8.33% of the pay will be for EPS.  

The present rate of interest for EPF is 8.55% and is calculated based on your monthly running balance. Suppose you earn a basic salary of Rs. 50,000, your EPF balance at the end of one year will Rs. 1.29 lakhs given the present interest rate. If you include your EPS balance, it will be Rs. 1.34 lakhs. 

Now, EPF subscribers can withdraw 75% of their total account balance after one month of resigning from their job.  

Did you know? The government will pay the employer’s contribution of 12% towards your EPF and EPS for 3 years if you are a new employee and have opened your EPF account on or after April 1, 2016. However, your basic salary should be up to Rs. 15,000 per month. 

UnitLinked Insurance Plan (ULIP) 

Being a hybrid product, a part of your ULIP premium will go towards insurance cover while another part will be invested in the stock market. The premium that you pay qualifies for tax deductions under Section 80C and the returns that you will receive on maturity will also be exempt from tax under Section 10(10D) of the Income Tax Act. 

According to the Insurance Regulatory and Development Authority of India (IRDAI), the maximum fund management charges can be 1.35% for a year. It has also said that the minimum insurance cover has to be 10 times the annual premium. These guidelines ensure that the charges don’t lower the returns and the insurance cover is not insignificant. 

You can choose from fund options provided by the insurer that come with varying asset allocations. Based on your risk appetite, you could invest more in equity, debt or have a balanced approach by investing in both equity and debt. You could get post-tax returns of about 7%-9% from ULIPs. 

Additional Reading: ULIPs vs Mutual Funds – What Should You Pick? 

In the case of market volatility, you can switch between equity and debt. Insurers allow a number of free switches every year.  

Did you know? There are ULIPs that pay the assured sum value plus the invested fund’s value to the nominee. This means you get money from the insurance cover as well as the investment made. 

Sukanya Samridhi Yojana (SSY) 

Have a girl child? Then, SSY is one of the best long-term investments that provide tax-free returns. The scheme’s interest rate is 8.1% now. The amount invested can be claimed as a tax deduction under Section 80C. The minimum deposit amount is Rs. 250 and you can invest Rs. 1.5 lakhs during a financial year. 

You can open an SSY account until your child turns 10. You can operate the account until she gets married or 21 years from the date of opening the account, whichever is earlier. You can make a partial withdrawal for your child’s education when she turns 18 years.  

Did you know? SSY interest is calculated every month on the lowest balance between the 10th of the month and the end of that month. So, invest your money in the SSY account by the 10th of the month. 

Psst! Long-Term Capital Gains (LTCG) from Mutual Funds are tax-free for gains of up to Rs. 1 lakh. Anything more than that will be taxed at just 10%. Interested? Mutual Funds with returns of up to 22% are right here! 

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