Invest for tax benefits, but with a plan
Saving on taxes appeals to everyone. It puts more money in your pocket to spend or save as you please. For most people, tax-saving investments tend to happen arbitrarily, and more often than not, at the last minute. However, if you took a little effort to plan these investments, then apart from saving taxes, they can contribute towards your overall financial goals as well.
“Remember that financial goal planning precedes tax planning. Once you have established the road map, ensure you have maximum tax efficiency planned for every year,” said Amit Kukreja, founder, WealthBeing Advisors.
There are no good or bad tax advantaged investments. The choice depends upon what you want from your investment.
Be aware of what you get
Know the type of tax benefit you are likely to get from investing in an instrument. Some of them provide a deduction from the total income and thus provide a way to reduce the tax that you have to pay. These include the deductions for specified investments such as the Public Provident Fund (PPF), National Savings Certificate (NSC), equity-linked savings schemes (ELSS) of mutual funds or payments and expenses such as interest and repayment of home loan and education fees of children and other deductions allowed under section 80C of the Income-tax Act, 1961.
Delhi-based lawyers Anumeha Verma Sinha, 29, and Neelesh Sinha, 30, follow this strategy of tax-saving with a plan. “We plan to buy a house in 2019 and have been investing in financial products that will help us in fulfilling this goal, and also save on taxes every year,” said Neelesh. He added that he has been investing in PPF for quite some time now, apart from investing in tax-saving fixed deposits (FDs). The couple, married for over 2 years, admit that they had made some financial mistakes in the past and it’s only now that they are becoming more aware of investment basics. They plan to start investing in mutual funds and do currency trading this year.
There are some instruments that come with the benefit of exemption from tax on the income earned. For example, specified bonds issued by institutions such as Housing and Urban Development Corporation (Hudco) and Indian Railways Finance Corp. (IRFC) provide interest income that is exempt from tax. Then there are specified bonds that are used to avoid taxes on long-term capital gains from transfer of any capital asset, if the gains are invested in these bonds within a given period.
“Identify products that help you reach your goals. Tax efficiency is a secondary yet quintessential factor. It should be linked to the process of identifying suitable products. For example, monthly deposit in PPF or EPF (Employees’ Provident Fund) or NPS (National Pension System) account is a good tool to help build a nest egg and get tax efficiency as well. Buying a house using a home loan brings you tax efficiency as well fulfilment of a financial goal. Donating money to registered bodies for a social cause gets tax efficiency and meets social obligations,” added Kukreja.
Know the tax benefit and how a product meets your requirements before you invest in it. For example, your investment may lose out on compounding benefits if due care is not taken to immediately re-invest the interest that is periodically received from some bonds. Similarly, buying tax-saving instruments with lock-in periods at a stage when liquidity is of primary importance to the investor will not help her.
Equity or debt?
Tax-saving instruments may be equity- or debt-oriented. For example, ELSS and Rajiv Gandhi Equity Savings Scheme (RGESS) are equity-related. Many others, such as NSC, PPF, loan repayments and some FDs with banks, are debt-oriented. Choose products not only for the tax benefit that they provide but also for their alignment with your overall portfolio’s asset allocation, which would have been decided based on your need for growth or income and ability to take risk. Investing in an ELSS when your portfolio is oriented towards debt will introduce an element of risk that you may be unwilling to take.
Consider the investments already made before you decide on your tax-saving instruments.
Addition of debt–oriented tax-saving instruments when you have already invested in, say, EPF, PPF or some bank FDs, may make the portfolio more debt heavy than what you intended it to be. So, don’t forget to consider the big picture when selecting for tax benefits.
Invest for your goals
Your tax-oriented investments are part of your portfolio, and as such have to be aligned to your goals as far as possible. If you are at a stage when you need income periodically, for example, to pay school or college fees or as retirement income, then an instrument like PPF, where interest is cumulated, may not be the ideal one. A bank FD that gives you the benefit of deduction from taxable income at the time of making the deposit and periodic interest payments to meet your income needs, or a bond that pays tax-free interest income, may be more in line with your goals.
On the other hand, if your goals are long term, then investments that give compounding benefits, such as PPF, or equity-oriented investments, are ideal.
“Always link your selection to a purpose or financial goal. If it is an investment, ensure that chosen product beats inflation. If it is an insurance product, ensure the cover is strong. Products that combine insurance and investment must be avoided,” said Kukreja.
Income and saving ability
Keep your saving and investment goals primary; tax-saving is secondary. After all, what you earn and save determines how much benefit one can take through these tax-saving instruments. If saving is low, then one may not be able to avail the full benefit available. “For the benefits under section 80C, one requires Rs.1.5 lakh of investment. But if savings are low, this surplus might become difficult to allocate,” said Jitendra Solanki, founder, JS Financial Advisors.
Investing in products with lock-in periods when you do not have an emergency fund in place may push you into debt should there be a sudden need for money. Committing to buying a large asset like a house, just because the home loan has tax benefits may increase your liabilities too much and your income may be stretched beyond what it can bear, which will put other needs at risk.
Maximise tax benefits
Explore all tax benefits available and use the ones that are most useful. There are a wide array of investments that you can select from. Evaluate the features—risk and return, tenor and lock-in, flexibility in making the investment and receiving returns—and align them to your particular circumstances in terms of ability to take risks, need for liquidity and investment horizon.
Look beyond the popular tax saving instruments to find ones that really suit your needs. For example, you may be better served by utilizing the increased deduction of up to Rs.25,000 available on premiums paid on health insurance to provide health cover to your family, or shoring up your retirement corpus by using the additional benefit of Rs.50,000 available on NPS.
Plan your investments, whether they provide tax benefits or not, as a whole, keeping your goals and financial situation in mind. Don’t see the money saved on taxes as free money only to spend as you please; use it to catch up with your financial goals.