What tax saving is NOT

Feb 04, 2019

Don’t ever ignore the opportunity to (legally) save on taxes just because it is cumbersome. The less tax you pay, the more disposable income in your hands to either spend or invest.

The actual tax strategy will have a different meaning and emphasis depending upon an individual's personal circumstances.

It is NOT only about fixed return instruments

Individuals tend to look at the Senior Citizen Savings Scheme (SCSS), 5-year deposits, National Savings Certificate (NSC), Public Provident Fund (PPF), and Unit Linked Insurance Plans (ULIPs) as the tax-saving investment avenues.

But you can also invest in an Equity Linked Savings Scheme, or ELSS. These are diversified equity mutual funds that offer a tax benefit under Section 80C. They have the lowest lock-in period of just three years.

As of today, the ELSS category average delivered an annualised return of 12% over three years. Do note, that was just the category average. Individual funds could have delivered even more. For instance, the chart topper delivered almost 20%.

Having said that, keep in mind that these are equity funds which means, the return is far from guaranteed. So pick a well-managed fund and stick with it over the long haul. Don’t be in a tearing hurry to sell your fund units on completion of three years. Exit from the fund when the market is rallying so you walk away with a profit. If this means hanging on for a few more years, do so.

(This week, we shall also write on how to pick a good ELSS and our analysts views on some of them.)

It is NOT only about investing

Tax saving is more than just investments.

Under Section 80C, you can show your child’s education fees to avail of a deduction. Ditto with the principal repayment of a home loan. When deciding how much to invest under Section 80C, first take into account children’s tuition fees, principal repayment on home loan, contribution to Employees Provident Fund (EPF), and any life insurance premium you are already paying. In the case of the latter, the deduction is valid only if the premium is less than 10% of the sum assured. Investments in the Sukanya Samriddhi scheme also fall under the Section 80C limit.

If, after the above, you have not already maxed the Rs 1.50 lakh limit, then you can look at the investment options available, such as PPF, NSC and ELSS. However, even if you have maxed your limit but hold a PPF account, then deposit at least the minimum to keep the PPF account running.

Go beyond Section 80C too. Paying of premium on a medical insurance policy for yourself and dependents, servicing of an education loan, interest payments on home loans, a donation to a recognized charity, all qualify for deductions.

It is NOT about a piecemeal approach

You cannot afford to be complacent when it comes to tax planning. Good tax management can go a long way toward enhancing your return. But the decision needs to be made in conjunction with your overall portfolio and not in an ad-hoc fashion.

Most individuals rarely think about tax planning from an investment point of view. Hence one finds that they do not approach an investment with a perspective of whether or not it fits in with their overall portfolio. The approach is often just grabbing up investments that will give them the tax break, irrespective of whether or not it will help them reach their determined financial goals or fit into an overall investment strategy.

Tax planning investments are no different from conventional investments. Hence, it is imperative to obtain an in-depth understanding of all investment avenues available which offer tax benefits and choose suitable ones that will help save tax and achieve goals.

Individuals approach investing with the question: What are the tax consequences of my current investment strategy?

They rarely approach tax planning with the question: What are the portfolio consequences of my current tax saving strategy?

Don’t make this error. You can read more about it in The biggest tax planning mistake.

A version of this article appeared earlier on the website.

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