Every year, thousands of individual taxpayers hastily invest lumpsum amounts in tax saving investments, to beat the 31st March cut-off. In their haste to save up on taxes, most investors end up buying products they don’t need and entering commitments they cannot honor.
Financial planners recommend that individuals should plan their investments well ahead of the stipulated deadlines. In fact, they suggest making it a year-long affair rather than an activity left for the last quarter.
So how should one go about a year-long tax planning exercise? Below are some tips:
Invest Regularly, Avoid Lump-Sums
Instead of jostling at the year-end, invest small amounts throughout the year. This is possible with ELSS mutual funds that allow investors to claim tax exemptions up to Rs. 1.5 lakh per annum under Section 80C of the Income Tax Act, 1961. Since these funds invest in equity markets, they have the potential to generate wealth in the long-term.
Investing in ELSS through the SIP route allows you to buy regularly and spread out your risks. It also allows you to be systematic while helping you build a habit of saving regularly. Select a date (of the month) you are comfortable with (based on your cash flows) and give standing instructions to your bank.
Do Not Combine Investments and Insurance for Tax Saving
This is perhaps one of the most popular thumb-rules in personal finance. Every financial tool has its specific purpose. Hence, while mutual funds are designed to offer long-term wealth creation, term plans offered by life insurance companies are suggested for availing life cover. Investing in products that combine the two might seem efficient, but it is not a costeffective idea.
Avoid Long-Term Commitments
In the urge to reduce the tax burden, individuals often end up investing in financial tools with multi-year lock-in periods. One such example is PPF. Even though this is effective for availing tax benefits, it has a 15-year lock-in period.
Similarly, most life insurance plans warrant long-term commitments and lock-in periods up to 5 years. Avoid investing in such products without fully understanding the associated liabilities. Instead, options like ELSS can be considered.
Look Beyond Tax Savings
While tax saving is a goal, it should not be the driver for your investment decisions. Ideally, every investment should correspond to a specific financial purpose. Do not invest without matching the features and benefits of the product with your needs.
For example, the National Pension System (NPS) has gained immense popularity post introduction of an additional tax benefit of Rs. 50,000 per annum under the Section 80CCD (1B). However, with NPS you can only withdraw funds when you are 60 years old. Even then, only 40% of the maturity benefit is tax exempted. Out of the remaining 60%, 40% is utilized to provide annuity benefits to investors and only 20% can be withdrawn. Income from both these sources attracts a tax liability.
Hence, when it comes to tax savings, don’t wait. It is wiser to be systematic because most ideas, like SIPs, run on an auto-mode!
For more such insights about mutual funds and personal finance keep visiting the IDFC MF website. Or
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