With financial year drawing to a close, just over a month remains to get your taxes and investments organised. People who wait until the end of the financial year to plan their taxes must be scrambling to make some investments to reduce their tax liability. While they may manage to lower their total tax outgo, their investments are unlikely to align well with their financial goals. The last-minute tax planning may also put pressure on their monthly earnings due to immediate outflow of money.
“Taxpayers making last-minute tax savings tend to invest without adequately analysing the returns, risk and other benefits from their investments,” says Archit Gupta, Founder and CEO, Cleartax.
Make sure to avoid following mistakes as you do your tax planning this year:
1) Not calculating your taxable income
The first step before you do any tax planning is to calculate your tax liability. Income tax on the salary is just one part of it. You may have some business income, rent from your property, interest earned from deposits, capital gains from stocks, mutual funds and gold or any other income that you may have. Unless you don’t calculate your taxable income, you wouldn’t know exactly how much deductions you should aim for reducing your taxable income.
2) Not taking into account already saved taxes
Each salaried person receives a standard deduction of Rs 50,000. If you pay house rent, school tuition fees for your children, or home loan principal and interest, you get deductions on your taxable income. Make sure to figure out all that you may have already saved before you look for any further adjustments in your taxable income.
“Taxpayers should figure out how much they actually need to save to exhaust fully the Section 80C deduction limit of Rs 1.5 lakh. For example, they should factor in the EPF which has already been deducted by the employer as their own contribution and also the repayment of principal on housing loan or tuition fees, etc. If after factoring in these payments, they still need to invest, a variety of options are available to choose, namely, contribution to voluntary provident fund (VPF), public provident fund (PPF), National Pension System (NPS), National Savings Certificate (NSC), Equity-Linked Savings Scheme (ELSS), unit-linked insurance plans (ULIPs), Sukanya Samriddhi Yojana, and fixed deposits with banks, etc,” says Kuldip Kumar, Partner and Leader – Personal Tax, PwC India.
3) Not aligning financial goals with investments
Tax saving should not have a piecemeal approach to it. Avoid zeroing in on a financial product only for the purpose of tax planning without evaluating if it aligns with your financial goals.
“Saving tax should not be the only consideration while deciding on investments as it is only a part of the puzzle and a means to an end, but not an end in itself,” says chartered accountant Amitabh Sethi. “For example, if you are choosing a money back life insurance policy for saving tax and building a financial corpus it may not be a wise option as there are other effective products for building wealth along with tax saving.”
So, this year as you choose a financial product to invest, you should link it with your specific goals. “If you are a young employee yet to get married, you may possibly need some money in the near future. In such a case, you may like to go for investment options with shorter maturity or at least those that give you an option to cash out if need be. On the other hand, if you are married and have school-going children, saving for the future may be the priority. In such a situation, you may like to go for investments with longer period of maturity such as VPF, PPF, ELSS, ULIPs and NPS, etc,” says Kumar of PwC India.
4) Wrong approach to insurance
In a bid to meet Section 80C requirement, taxpayers tend to buy insurance policies and end up having endowment and ULIPs that have savings component to it along with the death cover. You must know that the primary objective of buying an insurance is to protect your family financially in case you meet an unfortunate incident. Endowment and ULIPs may not give you enough death cover despite charging higher premium.
“The decision to buy insurance should be based on the extent of insurance coverage required (both for life and health) and not simply based on the premium amount to save the taxes. So, a term life insurance policy is well suited to meet the life insurance needs and a family floater health insurance policy will serve the health coverage requirements for most individuals,” says Sethi.
5) Not knowing rate of returns for better investment planning
Most taxpayers do not know exactly how much returns various investment avenues such as EPF, PPF, ELSS and NPS will offer. If they know it, they can accordingly choose their investment options. For example, if you want a fixed rate of return on your investments, you may prefer VPF over PPF if your employer allows for it because rate of return on VPF is 8.65 per cent currently compared to 7.9 per cent on PPF. Also, you won’t need the investment proof if you take the VPF route. VPF is a voluntary contribution by employees towards the provident fund over and above their own 12 per cent contribution. You may also consider Sukanya Samriddhi Yojana that is offering 8.4 per cent returns currently.
If you are an investor with good enough risk appetite, you may consider ELSS. However, late in the financial year, any significant tax relief will require you to invest lumpsum in one plan or diversify the investment into various mutual fund houses. Both may not be a good strategy from investment point of view. It is advisable to invest in ELSS via a systematic investment plan (SIP) in smaller chunks each month.
This financial year, you may have delayed your investments closer to the deadline, make sure to start doing it from the April itself in the next financial year. One of the major disadvantages of not doing so is losing out on the power of compounding. The sooner in the financial year you start your investments, the better returns you will earn on the same.