Around this time every year, you will see frequent advertisements of tax saving financial products in the print and electronic media. There would be countless posts on financial blogs about how to save tax under S/80C and innovative ways to save tax beyond this section. It becomes a priority as the year draws to a close and investments are then done in a haphazard manner with the sole objective of saving tax.
This is the typical tendency of majority of investors as they do tax planning at the near end of a financial year. Tax saving takes precedence over investment planning. Let us examine the problems associated with such hurried approach of tax planning.
Tax saving decisions not aligned with financial goals : Usually during the March quarter of a year, investors get obsessed with the word 80C. With limited time on hand to submit tax proofs to the HR department in their organisation, investors become vulnerable and usually fall prey to crooked agents.
Endowment policies and unit linked insurance plans (ULIPs) are the typical products pitched to investors to take benefit of section 80C. Just to save tax in a particular year, investors buy life insurance policies committing to pay premiums for 20-25 years. These policies are very expensive as they yield abysmal returns in the long run with high premiums and a small cover. Worse still, majority investors discontinue the policies once they realize they cannot afford the premiums and suffer losses. Not only do they stay grossly underinsured but also miss out on better investment opportunities which could have yielded higher returns than the traditional policies. Such haphazard tax planning affects both their insurance and investment goals.
Investing huge funds in one shot to save paltry tax amounts : Many a times, people do not understand the basic calculation of arriving at taxable income after taking into account all exemptions and deductions of the Income Tax Act. As a result, they invest a huge sum just to save tax in products that do not suit their requirement & risk appetite.
The Rajiv Gandhi Equity Savings Scheme launched in 2012 is a real case to cite. The scheme solicits funds into direct equity, mainly for first time investors. Only investors having a gross annual income of less than Rs.10 lakh (in the 10-20 per cent tax bracket) are eligible to invest in the scheme. It has a lock-in period of 3 years with redemption rules (cannot sell in the first year at all!) too complicated for a beginner to understand. The maximum investment limit is Rs.50,000 and the tax benefit available is 50 per cent of this limit, i.e., only Rs.25,000 is eligible for deduction. This means if you fall under the 10-20 per cent tax bracket, you would be able to save a measly Rs.2,500-5,000 on a huge investment of Rs.50,000.
The RGESS is thus not a good deal for investors looking to save paltry tax amounts given the associated volatility and complex redemption rules of the scheme.
The Right Approach
Rather than making new investments with the objective of saving tax, you should chart out your financial plan first. Once your current situation and financial goals, both short term and long term are articulated, an investment planning exercise can be done. Suiting your requirement and risk profile, an asset allocation can be decided which would give you the choice of multiple investment products. Depending upon your goal horizon, you can invest in them and in due process also save tax to the maximum limit. For instance, you have chosen PPF to invest for retirement. You know a fixed amount needs to be saved and invested every year, and importantly, at the beginning of the financial year as you would not lose out on the entire year’s interest. In this manner, your investments stay aligned with you financial goal of retirement and you also avail tax benefit.
Remember, tax planning is secondary to investment planning and not the other way round.