Mistakes to avoid while tax-planning

Tax planning should be regarded as a process and not a year-end activity. If you have not yet started tax-saving investments for the current financial year, you should not delay it further. 

The more tax you save, the more disposable income you will have. That is a good enough reason to take your tax-saving exercise seriously. This piece will discuss some essential points you should consider for tax saving. 

Avoid making last-minute investments.

Most taxpayers only make tax-saving investments in the last quarter of the financial year. This may lead to wrong investments in a hurry as the March 31 deadline looms all over. 

Suppose you are a risk-averse investor; choosing to invest in PPF and tax-saver FDs is more appropriate. 

Hence, if you want to build a healthy financial life, then ensure that your money goes towards investments in a planned manner. Investing regularly will help minimise the financial burden of investment in the last quarter.

You may lose on the rupee-cost averaging benefit if you invest in ELSS in bulk towards the end of the year. The investment plan must be proactive and not reactive. Do not make it a hurried exercise towards the end of the year just for the sake of tax saving where you pick up anything because you don’t know what else to do.  

Link your tax-saving investments to your financial goals

People generally forget to link their tax-saving instruments with their goals, which costs them a lot in the future. 

While investing in long term tax-saving investments like PPF, EPF, ULIPs, life insurance, ELSS, it is essential to link them to your long-term future goal so that you do not exist in the mid-way. Even when you invest in ELSS, having the shortest lock-in period, you need to link it with a particular goal and extend it until you get the desired amount for your goal. 

Proper tax management can go a long way towards increasing your return. But the decision needs to be made in conjunction with your overall portfolio. 

People rarely think about tax planning from an investment point of view. They usually grab up investments that will give them the tax break to help them reach their determined financial goals. Do not make this mistake, and align your investments with your financial goals. 

If you think Section 80C is only about investing

Section 80C allows you to claim a deduction of up to Rs 1.5 lakh of your total income, which means you can reduce up to Rs.1.5 lakh from your total taxable income. 

Investing in Equity Linked Savings Schemes (ELSS), Public Provident Fund (PPF), National Savings Certificate (NSC), National Pension Scheme (NPS), five-year fixed deposits with the bank or post office, Senior Citizen Savings Scheme (SCSS), and Sukanya Samriddhi (specifically for the girl child) all fall under Section 80C. An additional deduction of Rs.50,000 can be claimed for investment in NPS under Section 80CCD (1B) over and above the Rs.1.5 lakh limit of 80C. All these investments mentioned above fall under this umbrella.

But, Section 80C also includes tax deductions for certain expenses incurred by the taxpayer. For instance, payment of life insurance premiums, tuition fees for children, repayment of the principal amount of a home loan can also be claimed as deduction. This deduction is also allowed for stamp duty, registration fees and transfer expenses incurred by the taxpayer.

To reap maximum benefits under this section, first, claim the expenses eligible for deduction under Section 80C. Then the unutilised balance limit of Section 80C can be exhausted by investing in suitable tax-saving investment options which align with your long term financial goals.

Not exhausting all the tax-saving avenues.  

Apart from the Section 80C deduction, if you live on rent or stay at your parent’s place, you can claim the benefit of House Rent Allowance (HRA). Do not forget to claim leave travel allowance (LTA) exemption, any amount donated under Section 80G, interest paid on education loan under Section 80E, etc. One can claim deduction under Section 80D up to Rs.25,000 for medical insurance premium for self, spouse and children. Additional deduction for medical insurance for parents can be claimed up to Rs.50,000 if they are senior citizens. 

One additional point many people are unaware of Section 80D is that deduction for medical expenses can be claimed up to Rs.50,000 for treatment of dependent senior citizens who do not have any insurance cover. Here, note that we are not discussing medical insurance but expenses incurred on uninsured senior citizens.

Knowing tax implications on tax-saving investments

While making tax-saving investments, you must know how returns from these instruments will be taxed. For instance, interest earned from (NSC) National Savings Certificate & five-year tax-saving bank FDs are added to the taxpayer’s taxable income and taxed per individual income tax slab. Hence, if you fall under a 30% or higher tax slab, then post-tax returns from these instruments may fetch low returns. In contrast, if you invest in PPF (up to Rs.1.5 lakh annually), your returns will be tax-free. 

Knowing tax implications on all stages of investments, i.e. initial investment, interest or returns earned, and the withdrawal stage, is very important to make investment decisions so that there is minimum tax-outflow.  

Considering liquidity before investing.

It would be best to consider your liquidity needs while investing in tax-saving tools. Most tax-saving investments have long lock-in periods and can’t be sold before the lock-in to generate cash if it is urgently required. For example, if you invest in NPS under 80CCD (1b), these investments have a lengthy lock-in and cannot be withdrawn before retirement. 

Your tax-saving investments should be such that they meet your cash flows requirements. If you are fine putting in some money till retirement, then great! Go for it! But if you want high liquidity or have financial goals that need funds in the short term, you should consider the liquidity aspect of all tax-saving investments. 

It is worth mentioning that ELSS has the shortest lock-in of 3 years. So you may consider parking some money in ELSS every year so that in case of an emergency, you can withdraw them partially. If the markets witness a significant rally, you can book partial profit and deploy them again if markets fall. 

Clubbing insurance and investment

Keep your insurance and tax-saving investments separate. Traditional life insurance products, which combine term insurance and debt investment, generate poor returns and are much lower than PPF and other small savings schemes. They also have long tenures, inferior liquidity, closure penalties and low returns.

One should consider these points before investing in any tax saving options. It would be best to clarify tax implications on the income earned from such investment. Evaluate the post-tax returns these investments offer, compare their returns and other parameters like the risk involved, liquidity, volatility, lock-in period, etc., with other instruments, not necessarily tax-saving ones. Choose the mix of those tax-saving investments that are best suited to your needs. 

Also, try to include your tax-saving investments in your overall financial plan by linking them to your financial goals. For this, obtain an in-depth understanding of all investment avenues, or you may consider consulting an investment advisor. 

For any clarifications/feedback on the topic, please get in touch with the writer at jyoti.arora@cleartax.in.

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