Income Tax: Who doesn’t want to save money? But, this is not everyone’s cup of tea.
Income Tax: Who doesn’t want to save money? But, this is not everyone’s cup of tea. However, if your investment strategy is right them it’s not very tough. The last quarter of the financial year leads many taxpayers towards last minute rush for making tax saving investments. In process, we may commit numerous investment mistakes having long term implications for their financial future. Sahil Arora – Director, Paisabazaar.com reveals some of the most common investment mistakes and shows the ways in which we can avoid them:-
1- Not calculating and comparing tax liability under old and new tax regime
Budget 2020 introduced a new tax regime with lower tax rates to reduce tax liability of investors unable to avail various tax deductions and exemptions available under the old tax regime. However, as the new regime is optional and taxpayers can continue with the old tax regime if they wish to, one should calculate the tax liability under both new and old regimes and go ahead with the regime under which they have least tax outgo. Those opting for the new regime should keep in mind that while it has lower tax rates, they have to forgo numerous deductions and exemptions for it available under the old regime.
2- Not factoring in compulsory payments or investments qualifying for tax deductions
Section 80C is crowded with numerous tax saving instruments or expenses, many of which are unavoidable in nature. Examples include EPF contribution by the employees, mandatory NPS contribution by government or corporate employees, premiums paid for term insurance plans, repayment of home loan principal component, etc. Similarly, repayment of home loan interest component qualifies for tax deduction under Section 24b, interest repayment of education loan qualifies for tax deduction under Section 80E, premiums paid for health insurance policies qualify for tax deduction under Section 80D, rent paid qualifies for tax deduction under Section 10(13A) or 80GG, etc.
Hence, investors should start their tax planning journey right from the start of the financial year by preparing a rough estimate of their annual income for that financial year and the mandatory expenses or investments that would qualify for tax deductions under various sections. The residual amount left for claiming tax deductions under Section 80C should then be routed for tax saving under Section 80C and Section 80CCD 1B (in case of NPS subscribers).
Undertaking this exercise will save you from over-investing or under-investing in tax saving instruments. Remember that while under-investing will increase your tax liability, over-investing will unnecessarily comprise your liquidity by blocking your investments in instruments with lock-in periods when similar instruments within the same asset class would be available without any lock-in periods.
3- Mixing insurance with investment
Avoid mixing insurance and investment. Taxpayers often tend to mix up insurance with investment and thereby, end up investing in endowment policies, money back policies or ULIPs. These products do not provide adequate cover, generate sub-optimal returns and have low liquidity features.
The primary purpose of purchasing a life insurance policy should always be providing a replacement income for your family in the event of your untimely demise. Ideally, the life cover of any individual should be at least 10-15 times of your annual income. Term insurance is the best product for buying adequate life insurance as they are available at very low premium. Mutual funds are best suited for long term wealth creation as they have higher liquidity and offer greater product choice to suit various risk appetites. Additionally, Equity Linked Savings Schemes (ELSS), popularly known as tax saving mutual funds, are eligible for Section 80C deduction while offering the shortest lock-in period of just 3 years.
4- Restricting your tax saving portfolio to fixed income instruments
The risk averse nature of a sizable section of tax payers stop them from investing in market linked instruments like ELSS even if they offer higher returns than fixed income products like PPF, tax saving bank fixed deposits, National Saving Certificates (NSC), etc. Being primarily invested in equities, ELSS has the potential to beat fixed income instruments and inflation by a wide margin over the long term. By offering the shortest lock in a period of three years, ELSS also gives a higher degree of liquidity than the traditional fixed income tax saving instruments.
5- Timing your tax saving investments:
Many among those who invest in ELSS to save tax under Section 80C tend to postpone their tax saving investments in the hope of investing during market corrections or bearish phase. However, this strategy can backfire if the equity market continues its upward trend till the end of the financial year without any major dips or corrections. This might force them to invest at higher levels at the end of the financial year. Instead, investors should use SIP mode of investment to spread their tax-saving investments throughout the year. These will help them to average their investments in case of corrections. In case of any steep correction or a bearish phase, the investor can always top-up his ELSS SIP with lump sum investments and stop or pause the ELSS SIP for that financial year on achieving the targeted tax saving investment.
