Do not make these 5 tax-planning mistakes

By Larissa Fernand |  10-01-23 | 
 

Don’t ever ignore the opportunity to (legally) save on taxes just because it is a bit of a bother. The less tax you pay, the more disposable income in your hands to either spend or invest. And that should be motivation enough to get rid of your nonchalant attitude towards tax planning.

Having said that, 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.

Quick Take: Tax Planning is NOT separate from Financial Planning

Mistake 1: Thinking that tax saving is only about investing.

No.

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 spouse and children is a tax-saving payment.

Tuition refers to 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.

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 get a tax break.

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Mistake 2: Thinking that you MUST opt for a tax-saving investment product.

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

If you are a salaried employee, check the annual contribution to the Employee Provident Fund, or EPF. This is included under the Section 80C limit. It 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. If the employee decides to contribute more than the minimum 12%, it is terms as the 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. Technically, employees can contribute up to 100% of their basic salary towards the scheme, but it is not mandatory for employers or employees to contribute to the VPF.

Once this is done, you may realise that you do not need to invest in PPF, NSC, ELSS, or 5-year bank deposits to save on tax. You may choose to invest, but that is different.

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Mistake 3: Assuming that tax saving is only about fixed return instruments.

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.

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Mistake 4: Assuming that tax saving is only about minimizing the tax outgo.

Individuals buy life insurance with the sole 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.

Also, a general rule to follow is to avoid products that club insurance and investments. Insurance is for protection, investment is for wealth creation.

There are always legal ways to mitigate the impact of income tax. But make sure it’s not some harebrained plan that will work against you. Don’t stash away money in financial products just to save tax; ensure that it serves your other investment goals. The goal of tax saving is not an end in itself, it must also aid your wealth creation.

When you approach tax saving with a holistic mindset, you are in a win-win situation. Because you can make sensible decisions only if you take an integrated view of your investments and goals. If you focus only on tax saving to the detriment of returns and product suitability, the price you end up paying could be really high. Unfortunately, you may realise it only much later, when it is probably too late.

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Mistake 5: Assuming that tax saving is a year-end activity.

In your mind, no longer refer to it as tax saving. Switch to tax planning instead. Once you change the way you frame it, you will approach it differently.

Folks hobble from one tax season to another. With no cohesive thought process, the ad-hoc decisions made at the end of the financial year defeat the very purpose of a smart portfolio. As long as individuals view tax planning as an annual occurrence at the start of the calendar year, their portfolio will bear testimony to their missteps.

In a crazy dash to meet their Section 80C requirement, they end up settling for unit linked insurance plans (ULIPs), and endowment plans. They often end up with products that are duplicated in their portfolio or do not suit their need. A portfolio bloated with insurance policies does not ensure that you are aptly covered, neither does it put you rightly on the path to wealth creation.

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.

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.

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