5 Most Common And Avoidable Tax Saving Mistakes
Morgan Stanley’s advertisement on tax-saving showed a catchy line, “You must pay taxes. But no law says you have to leave a tip.” The ad highlighted the importance of not ignoring the opportunity to legally save on taxes. Because, the lower amount of taxes you pay, the greater is your disposable income.
Mistake 1: Delaying Tax Saving Planning Till March
Many people delay executing a tax-saving plan until the end of a financial year, i.e., March. However, this is far from a good strategy. The truth is that the sooner you start working on your tax-saving planning, the better.
For instance, if you invest money in your PPF account in the first month of the financial year, you will receive a lot more tax-free interest for the year than investing the money in March.
Similarly, starting financial planning early in the financial year allows you the convenience of investing in an ELSS fund via the SIP route. Otherwise, you will have to put a large chunk of money later in the year. And this can be pretty troublesome from a cash flow perspective. Moreover, you may also end up borrowing money from credit cards to invest, which is a horrible idea.
So, don’t make the mistake of waiting until March to start your tax planning.
Mistake 2: Tax Saving Is Only About Investing
People often assume that tax saving is only about investing money in tax-saving products. It happens because much of the marketing effort is attracting your attention to products like ELSS, tax-saving fixed deposits, insurance policies, etc.
However, investing is only one part of sound tax management. The other important part that doesn’t receive due attention is how you manage your spending. Income tax laws allow for several deductions from your taxable income for certain expenditures that you make. For instance, payment of children’s tuition fees, health insurance premium, repayment of home loan, education loan, and house rent are expenses that quality for a tax deduction.
As a taxpayer, you need to explore all such tax-saving options to determine what works best for you. The more prepared you are with the tax laws, and the sooner you act on them, the better are your chances of minimizing your tax outgo.
Mistake 3: Not Evaluating Enough On Tax Saving Products
You can evaluate every tax-saving investment option on three broad parameters. The first parameter is liquidity, which simply means the ease you can access and withdraw your money when you need it. In this regard, you must have a clear understanding of the instrument’s lock-in period in addition to the premature withdrawal rules, including its taxability and penal charges.
The second broad parameter when evaluation a tax-saving financial product is the risk of losing money. Some investments are inherently volatile. And these are generally the investments that have some component of equity in them.
|INSTRUMENT||UNDERLYING ASSET CLASS||RISK (LOSS OF CAPITAL)||EXPECTED RETURNS *|
|Public Provident Fund||Debt||No||7 – 8%|
|Equity Linked Saving Scheme (ELSS)||Equity||Yes (Moderate)||12 – 14%|
|Sukanya Samriddhi Yojana||Debt||No||8%|
|National Savings Certificate||Debt||No||7%|
|Post Office Time Deposit||Debt||No||7%|
|Bank Tax-Saver Fixed Deposit||Debt||No||6 – 7%|
|National Pension System (NPS)||Equity & Debt||Yes (Low)||8 – 12%|
|Unit Linked Insurance Plans||Equity & Debt||Yes (Moderate)||7 – 12%|
* Estimates Based On Historical Performance; May Not Sustain In The Future
That said, it is also crucial to factor that the presence of equities allows instruments like ELSS, ULIPs, and even NPS to offer inflation-beating returns over the long run. So as an investor, you need to ask yourself how comfortable you are in tolerating some volatility in the portfolio to make more returns.
Finally, the third parameter you need to consider when picking tax-saving products is their post-tax returns.
|Public Provident Fund||Tax-Free|
|Equity Linked Saving Scheme||10% Tax Payable On Long Term Capital Gain Exceeding ₹1,00,000|
|Sukanya Samriddhi Yojana||Tax-Free|
|National Savings Certificate||Interest Earned Is Taxable|
|Post Office Time Deposit||Interest Earned Is Taxable|
|Bank Tax-Saver Fixed Deposit||Interest Earned Is Taxable|
|National Pension System||60% Maturity Is Tax-Free; Rest 40% Goes To Annuity Which Is Taxable|
|Unit Linked Insurance Plans||Mostly Tax-Free Except Where Annual Premium Exceeds ₹2,50,000|
Investors generally check for tax benefits in terms of the deduction it allows. For example, a PPF or ELSS offers deduction under Section 80C. NPS provides a little more.
But what’s equally important to understand is the taxation on the income earned by that asset. And also how the maturity proceeds and early withdrawals will be treated from a taxation perspective.
Understanding these aspects can not only help you zero in on the right investment product, but it can improve your post-tax returns as well.
A big problem with not having an acceptable awareness or knowledge of tax-saving instruments is the inherent inefficiency in the planning process. This inefficiency often passes down as a legacy from parents and other well-wishers.
Consequently, many investors continually invest in LIC policies and other small saving schemes that typically struggle to beat inflation. While such investments with subdued returns can help you save some taxes in a particular year, you may end up wasting a lot more in potential returns on your money by investing in these products.
Mistake 4: Investing In Insurance-Cum-Investing Products
Every year in March, millions of Indians blindly invest in traditional life insurance plans like endowment and money-back policies to save taxes.
Such is the last-minute rush that life insurance companies have effectively marketed the month of March as India’s tax-saving season. And it should come as no surprise that insurance companies rake in around 20% of the entire year’s traditional life insurance policy sales.
Now, from a utility perspective, these insurance-cum-investment plans offer meager returns and often struggle to catch up with the long-term inflation rate, which is about 6%. Not just that, these products deliver lower returns than what a PPF, National Savings Certificate, or other small savings schemes offer.
Additionally, these insurance plans come with an investment commitment that runs from 10 to 20 years, and any attempts at a premature withdrawal or policy closure attract a heavy penalty.
Mistake 5: Not Diversifying Your Tax Saving Investments
All the tax-saving products come with lock-in requirements. As a result, they seldom align with your short-term financial goals. That is why you must understand how these investments fit within your overall long-term financial goals.
Most individuals rarely look at their investments in PPF, EPF, and other instruments as part of their overall financial portfolio. In effect, such investors grossly miscalculate their asset allocation.
Consequently, they invest less in the equities and miss the chance to accumulate a bigger corpus in the long run. While they think they are in a particular risk profile, unfortunately, their investments are stuck in a different risk basket.
Tax planning investments are no different from conventional investments. The basic principles such as asset allocation or diversification apply to managing tax-saving investments as well. Now that you know the most common and avoidable tax-saving mistakes, you can reflect on how you work your tax-saving activities.