As the new year starts and the financial year sashays into the last quarter, there is a rush among people to get their tax savings in order. Naturally, everyone wants to save as much tax as they possibly and legally can.
But the problem is that just to save more taxes people end up putting money into random products, which are often not suitable for their requirements. It is like someone is offering you discounts on medicines you do not need, and yet you end up buying them just because of the discounts.
Saving taxes is not enough
Tax savings are important. But it should not be random. Tax-saving or tax-planning should be part of an overall investment plan. As an investment advisor, time and again I see new clients coming to me with a portfolio filled up with random investments made in several instruments each year just to save taxes. Often they have multiple life insurance plans, ULIPs, ELSS funds, and what not. This makes the portfolio a directionless assortment of unrelated clutter.
Most individuals are well aware of various tax-saving options that come under section 80C, 80D, 80E, 24B, etc., of the Income Tax Act. But generally, these people fail to align these tax-savings investments with their financial goals. As a result, tax planning for them becomes an annual ritual of sorts come January, rather than being part of proper financial planning.
Fit tax savings into overall financial planning
The very first thing to check is whether you really need to invest more specifically for tax-savings, or not.
Many mandatory investments and expenses (like EPF contributions, children’s school fees, home loan principal repayment, life insurance premiums, etc.) are already eligible for deductions under section 80C. Only if these are not enough to meet your section 80C limit of Rs 1.5 lakh should you think about additional tax-saving investments.
The second thing to check is if you are properly insured. If your life insurance cover is not enough, then please buy yourself a term life cover. The premiums you pay will be eligible for section 80C benefits.
Next, clearly define your financial goals. Say, you want to start investing seriously for your five-year old son’s higher education and your retirement in 25 years’ time. There can be different ways to make your goal-based investments save taxes as well.
Here is one way to look at it:
• Since your son is five and his higher education is at least 12 years away, you can consider investing in tax-saving ELSS funds that give you equity exposure that is suited for such long investment horizons.
• Regarding retirement, if your retirement portfolio is already debt-heavy like that of many people (due to a heavy EPF component), then even for this goal you can invest in ELSS funds to both increase equity exposure and save taxes. On the other hand, if your retirement corpus has a smaller PF and higher equity allocation, then you can increase your VPF contribution, which will also be eligible for tax savings under section 80C. If the VPF option is not available, for you then you can consider investing in PPF (read choosing between VPF and PPF).
• NPS investments up to Rs 50,000 each year get additional tax benefits under sub-section 80CCD (1B). NPS is a retirement-only product which is illiquid till your late 50s, and cannot be used for other goals. So for some people, even NPS make sense when planning for retirement. That way, they can get additional tax benefits as well.
So, your choice of tax-saving investments should be in sync with your goals.
Point to note when choosing tax-saving ELSS funds
When choosing equity-based tax-saving ELSS funds, remember that all ELSS funds are not alike. Some are large-cap oriented and others are mid- or smallcap oriented. If you already have a few equity funds in your portfolio, then pick an ELSS fund that gels well with them based on what overall allocation you want for different market-cap segments.
Don’t just blindly pick the highest star-rated or table-topper ELSS fund each year. And yes, you don’t need to choose a new ELSS fund each year.
That is how you can integrate tax-saving into your overall financial planning. You should never pick a product first. Always assess your goal, then choose the right asset allocation, and then pick the tax-saving product.
In the long run, the suitability of the tax-saving instrument for your goals is much more important than just tax-saving for the sake of tax-shaving. Never commit the mistake of considering tax planning as something separate from financial planning.
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