Avoid these 7 mistakes while making tax saving investments
November, 26th 2021
Tax planning is a process which should be done at the beginning of the year so that you get the whole year to make investments according to your plan. If you have not started making your tax-saving investments for the current financial year yet, then you should not delay it any further. When investors make tax-saving investments in haste or at the last moment, they usually commit mistakes. Worth mentioning here is that tax-saving investments should not just be made for the purpose of tax saving; they should also help you achieve your financial goal. the investor achieve his financial goals. Here are a few common mistakes you should avoid while making tax-saving investments
Not linking investments to goals
Typically when people invest in tax-saving instruments in a hurry they forget to link these investments with their goals, which in future, costs them a lot. If you are investing in tax-saving investments such as PPF, EPF, Ulips, life insurance, ELSS, which are long-term in nature, it is important to link these investments to a particular long-term future goal and do not exit the investment mid-way before reaching the desired goal. Even when you invest in ELSS, which has the shortest lock-in period, you need to link it with a particular goal and can extend it till you get the desired amount for your goal. You can also consider topping-up your ELSS investments with additional amount when markets see significant corrections.
Not knowing tax implication
While making tax-saving investments investors must know how returns from these instruments will be taxed. For example, the interest earned from National Savings Certificate (NSC) and five-year tax-saving bank fixed deposits are added to the taxable income of the taxpayer and are taxed as per his income tax slab. So if you are in a 30% or higher tax slab, then post-tax returns from these instruments will not be that attractive for you. But if you choose instruments like PPF, where you can invest up to Rs 1.5 lakh annually, your returns will be tax-free.
Making last-minute investments
Most of the taxpayers make tax-saving investments in the last quarter of the financial year only. In the last-minute rush, they often choose products that may not suit their requirement. For example, if you are a risk-averse investor, then choosing ELSS may not be appropriate for you. Similarly, if you are in a 30% or higher tax bracket, then investing in tax-saving fixed deposits in the last moment may not fetch you good returns.
So it is advisable to calculate your tax liability at the beginning of the financial year and then plan your tax-saving investments accordingly. Also, investing regularly will help reduce the financial burden of investment in the last quarter.
If you are investing in ELSS in the last minute, then you will miss out on rupee-cost averaging benefits and may buy them at higher NAV.
Choosing ELSS funds based on recent performance
Many taxpayers select ELSS funds that come with Section 80C tax benefit, based on only 1-year and 2-year performance. One should note that one particular MF scheme can not remain the top performing scheme forever. Every year a different MF scheme tops the return chart. So one should avoid the mistake of picking the top-performers of current year rather they should look at other factors like returns over a period of 10-years, risk-adjusted return, maximum portfolio drawdown etc.
Ignoring liquidity needs
You need to consider your liquidity needs when selecting a tax-saving investment. Most tax-saving investments have long lock-in periods and can’t be sold before the lock-in to generate cash in case of any requirement. For example, if you are investing in VPF for availing deduction under 80C, then you must note that VPF investment can not be withdrawn before retirement.
Your tax-saving investments should be such that you get cashflows in regular intervals to meet your financial needs. Worth mentioning here is that ELSS comes with the shortest lock-in of 3 years. So you should park some money in ELSS every year so that in case of an emergency you can withdraw them partially or if markets witness significant rally then you can book partial profit and deploy them again when markets fall.
Ignoring Section 80D and other benefits
In addition to Section 80C and Section 24B tax saving options, there are some other ways to save tax. Your health insurance premium, medical expenses on senior citizen parents and interest payment on an education loan can also help you save tax. Secondly, principal repayment towards home loan also qualifies for tax deduction under Section 80C. You should make use of these tax provisions while planning your tax-saving investments.
Clubbing insurance and investment
Keep your insurance and tax-saving investments separate. Traditional life insurance products, which combine a term insurance and debt investment, generate poor returns and are much lower than the returns of PPF and other small-savings schemes. They also have long tenures, low liquidity, closure penalties and low returns, say tax experts.