4 tax-saving assumptions that are wrong

By Larissa Fernand |  19-04-22 | 

Good tax management (saving and investing) 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.

Assumption: Tax saving is only about investing.

Section 80C allows you to claim a deduction of up to Rs 1.5 lakh of your total income. So you can reduce up to Rs 1,50,000 from your total taxable income.

Payment of life insurance premium, tuition fees for children, and repayment of the principal amount of a home loan are the expenses you must look at here.

The annual premium paid for life insurance in the name of the taxpayer or the taxpayer’s wife and children is a tax-saving payment.

When the word tuition is used, it is the fee paid for a full-time course to any school, college, university or educational institute situated in India. It is not private, out-of-school tuition. Neither is it for fees paid abroad. The caveat being that it is limited to two children only.

Besides, Section 80D allows a deduction on medical insurance premiums. If you are servicing an education loan, check for tax benefits under Section 80E. Home loan interest payments under Section 24 too get a tax break.

Assumption: Everyone must opt for a tax-saving investment product.

Here are three steps to follow.

First, look at the expenses permitted under Section 80C: principal home loans payments, life insurance premiums and children’s tuition fees.

Secondly, if you have not maxed the Rs 1.50 lakh limit with the above payments, then move on to check your provident fund contribution under EPF.

If you are a salaried employee, consider the annual contributions to the Employee Provident Fund, or EPF. They are included under the Section 80C limit. This is a retirement benefit scheme that is available to salaried employees; 12% of basic salary is deducted by an employer and deposited in the EPF.

This is all the more relevant in the case of Voluntary Provident Fund, or VPF. Here, the contributor decides on the amount of fixed contribution that is made towards the scheme on a monthly basis. Under the VPF, employees are allowed to make contributions towards their provident fund account on a voluntary basis. The scheme does not include the mandatory 12% that the employee makes towards the EPF. While technically, employees can contribute up to 100% of their basic salary towards the scheme, it is not mandatory for employers or employees to contribute to the VPF.

Finally, only if you still have not hit the Rs 1.50 lakh limit under Section 80C, should you consider any other investment (such as PPF, NSC, ELSS or 5-year bank deposits) to save tax.

Having said that, I invest Rs 1.5 lakh every single year in PPF because I like what the investment offers me. If I take into account other avenues under Section 80C, I need not invest that much in PPF. It is a personal choice. But, the tax benefit is restricted to Rs 1.5 lakh even if I exceed the amount.

Assumption: Tax saving is about fixed return instruments.

A number of individuals tend to look at the Senior Citizen Savings Scheme (SCSS), 5-year bank deposits, National Savings Certificate (NSC) and Public Provident Fund (PPF).

But under the tax-saving umbrella, there are also Unit Linked Insurance Plans (ULIP), Equity Linked Savings Schemes (ELSS), and the National Pension Scheme (NPS), all of which provide an equity exposure.

This is why you must always approach tax planning from the perspective of your overall portfolio. Your personal tax strategy will have a different meaning and emphasis depending upon your circumstances and risk capability. For instance, if your portfolio is heavily tilted towards fixed income instruments, it would not be wise to opt for an investment in NSC. Instead, consider an ELSS.

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.

As a result, it is not surprising to see portfolios heavily skewed towards ULIPs or endowment plans. Or probably packed with NSC, in addition to their EPF and PPF.

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.

Assumption: Tax saving can be done in January.

If you do your tax planning in January and February, you need to stop. You are most prone to making the wrong investment when it is done in a tearing hurry, with the March 31 deadline looming menacingly.

Start right away. You should invest in PPF at the very start of the financial year to avail of the benefit of compounding. If investing in an ELSS, it is wise to do so via a systematic investment plan (SIP) from April onwards. Do remember that SIPs are implemented for a minimum of 6 months or 12 months (though you can terminate it anytime).

If you want your money to work towards one goal, which is creating wealth, ensure that you approach it in an orderly fashion. Tax saving should be in sync with the overall strategy and not a hurried exercise at the end of the financial year, where you pick up anything simply because you don’t know what else to do. Tax optimisation of individual financial products has to be the last step in the overall financial plan and not the basis for selection.

In a crazy dash to meet their Section 80C requirement, most investors opt for unit linked insurance plans, or ULIPs, and endowment plans, and often end up with products that are duplicated in their portfolio or do not suit their need.

Or they buy life insurance policies. Insurance should never be bought with the intention of saving tax. Tax saving is just one of the benefits that come along with it. The main benefit is the provision of finances in the case of death of the policy holder.

Please Read

6 questions to answer when constructing your portfolio

3 things tax planning is NOT

Why you can't compare PPF with ELSS

4 tax-saving assumptions that are wrong

Does PPF fit into your portfolio? 7 questions on PPF answered  
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