If you have not begun your tax-saving investments yet, you should do so right away. Leaving it till March creates many issues. If you set out to invest at the last moment, you are likely to make a poor choice. A horde of sellers is out there trying to cash in on ignorant taxpayers’ last-minute rush. They could sell you products that pay them high commissions but are not in your best interests. Moreover, your employer will also ask for proof of tax-saving investments soon. If you fail to submit them, it will deduct tax at a higher rate from your salary during the last few months. You will then not only receive less money in your hands, you will also have to make your taxsaving investments out of that lower amount.
How much do you need to save
Begin by checking the tax saving expenditures and investments you have already done. Children’s tuition fee, home loan EMIs (principal and interest), Employees Provident Fund (EPF) deduction, insurance premiums, etc are all eligible for tax saving. After considering all these, the amount you have to invest to complete the Section 80C limit of Rs. 1.5 lakh may be lower than you imagined.
Are you adequately insured?
Before putting money in an investment product for tax saving, look at your insurance portfolio. Do you need additional term insurance? If yes, buy it. Term insurance premium is eligible for Section 80C benefit.Don’t depend only on the health insurance plan provided by your cover. Buy one of your own as well. The employer’s cover may not be adequate. It will also not be available if you decide to become an entrepreneur or a consultant. The health insurance premium is eligible for Section 80D benefit.
Consider your financial goals, liquidity requirement
Your tax-saving investments must not be ad hoc. They must help you achieve your financial goals. The choice of product must also depend on how far off your goal is. Use taxsaving products with long lock-in only if your goal is far off and you will not require the money in the interim.
Pay heed to asset allocation
Before investing in a tax-saving product, check where your current portfolio stands vis-a-vis your target asset allocation. Suppose that you face a choice between investing in an equity linked savings scheme (ELSS) and Public Provident Fund (PPF). If your current portfolio is tilted towards equities, then make the additional tax-saving investment in PPF, and vice versa.
Next, let us turn to some of the products best suited for tax saving.
ELSS: By investing in an ELSS or tax-saver mutual fund, investors can get the benefit of tax saving under Section 80C and the high returns that an equity scheme can offer in the long run. Among all tax saver products, ELSS has the shortest lock-in of three years.Equity investments, however, are subject to volatility. The compulsory lock-in helps cope with the volatility: Investors can’t withdraw the money when the markets are down even if they are tempted to exit. One risk in this product is that returns depend on the fund manager’s skills. If the fund manager underperforms, returns could be below the category average. One way you can circumvent this risk is by investing in the first passive fund within this category, based on the Nifty 50 index, which was recently launched by IIFL Mutual Fund.Don’t withdraw money from the ELSS as soon as the lock-in ends. Stay invested for at least five-seven years so that the fund completes one market cycle and is able to give you decent returns.It is best to invest in ELSS via a systematic investment plan, starting from April. If you invest a lump sum and the markets tank, that could have a psychological impact on you.
PPF: PPF is perhaps the best fixed-income product for long-term goals (after EPF) such as retirement or saving for children’s education. It offers a tax-free return of 7.1 per cent annually. The investment is also eligible for Section 80C benefit. However, bear in mind that it has a tenure of 15 years. It allows only limited withdrawal before the completion of tenure. You can make one withdrawal in a financial year after five years, excluding the year in which you opened the account.Another limitation is that the amount you can invest in a financial year is capped at Rs. 1.5 lakh.
National Pension System (NPS): This product is well suited for people in the higher income brackets, who are unlikely to need the money invested in the National Pension System (NPS) before retirement. One advantage of NPS is that you can get an additional tax deduction of Rs. 50,000 under Section 80CCD1(B). This Rs. 50,000 deduction is exclusive to NPS. This is over and above the Section 80C benefit of Rs. 1.5 lakh. The strong restrictions on withdrawal also mean that this is a product well suited for retirement saving.However, it is not an ideal product for someone who may need the money before retirement. If you withdraw before retirement, 80 per cent of the corpus has to be annuitised and only 20 per cent is paid out as lump-sum.
Voluntary Provident Fund (VPF): If your annual investment in EPF is lower than Rs. 2.5 lakh, consider boosting this amount to the Rs. 2.5 lakh level by investing in VPF. Here, again you can get a risk-free as well as tax-free return of 8.1 per cent. Employees should use up the Rs. 2.5 lakh limit to the hilt. The tax deduction at the time investment will be limited to Rs. 1.5 lakh under Section 80C.
SCSS and SSY: Among other products that may be considered, one is Senior Citizens Savings Scheme (SCSS), which offers a return of 7.6 per cent (taxable). This product is available to senior citizens only.Those who have a girl child of less than 10 years may consider investing in Sukanya Samriddhi Yojana (SSY), which offers a tax-free return of 7.6 per cent. Both SCSS and SSY are eligible for deduction under Section 80C.
Unit linked insurance plans (Ulips): If you belong to the category of investors that tends to withdraw money from mutual funds (because they are liquid) and spends it, consider Ulips. The five-year lock-in in these plans can work in your favour. If you buy them, make sure you opt for a low-cost Ulip.Ulips have a few shortcomings. If the funds you have invested in underperforms, you can shift to other funds belonging to the same insurer. But you can’t shift to a fund belonging to another insurer before five years.Of the premium you pay, a part gets invested while a small part goes towards providing insurance coverage. Unlike a term plan, where the premium remains constant after purchase, in a Ulip it keeps increasing with age. This reduces the portion that gets invested. Older people must consider this before investing.What to avoid? Most investors can do without traditional insurance policies (money back, endowment, etc). A big risk you run when you invest in these products is that you will be unable to buy adequate insurance cover to provide proper financial protection to your family. Buying adequate protection via a traditional plan becomes prohibitively costly (term insurance is better suited for this purpose).Since these policies mostly invest in debt products, their returns tend to be low, usually not more than 5-6 per cent.
Opinions expressed in the articles are of the authors and do not necessarily reflect those of editors or publishers. While the editors do their utmost to verify the information published, they do not accept responsibility for its accuracy. Please consult with your financial advisor before investing.
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