Things to remember when saving taxes

Choosing an instrument

Rate of return: The expected rate of return on an investment is of course extremely important. Generally, the rate of return would be inversely proportionate to the risk involved and, therefore, you need to seek the right balance between the rate of return and the risk that you are comfortable with. Of course, whether the return is taxable or not does make a significant difference to your choice, depending on your tax slab.

Liquidity: This is also an important factor. Is the interest being received at regular intervals or will it be received only on maturity? Is premature encashment of investment possible and after how many years? Answers to these questions affect your choice of investment, depending upon the need for liquidity that you have in the next few years.

Recurring payment: A very important aspect that many taxpayers tend to lose sight of is evaluating whether the payment for the investment or insurance has to be necessarily made each year for the same amount, whether one has the flexibility to adjust the amount in subsequent years, or whether one is making just one initial lump sum payment. Depending upon your other needs in subsequent years, taking on a recurring obligation for a significant amount may not be desirable in certain cases. For instance, if you are planning to acquire a house in the next year or two, it may not be advisable to take on a significant recurring obligation that you may find difficult to service in a subsequent year.

Tax treatment of accrued amount: The tax treatment of subsequent accrual of income is also a factor. For instance, in case of National Savings Certificates, the interest accrued is regarded as being reinvested, and qualifies for deduction in that year. This reduces the need for investment in subsequent years.

Things to remember

Do you really need the deduction? When deciding the amount of investment or insurance, do not forget to factor in other eligible payments by you, which already qualify for tax relief, such as children’s education fees, repayment of housing loan and Employees’ Provident Fund. Most tax-saving investments are worthwhile only due to the tax deduction that they provide. If your other qualifying amounts are already in excess of the eligible limit of 1 lakh, you do not get any additional tax deduction through investment in such instruments and such investment may not be worthwhile at all.

Who should claim deduction? Also, there may be some types of payments, such as life or medical insurance premiums, which other family members, such as parents, may be bearing, for which the benefit may not be available to them or be lower than the benefit available to you, on account of lower income. Section 80D allows deduction for mediclaim premium of parents, while section 80C allows deduction for life insurance premium of wife and children, including major children. Here, it may make sense for you to make the payment and claim the deduction, instead of the concerned family member.

Ultimately, what you primarily need to keep in mind is that tax planning is only a means, and not an end by itself. The purpose is to maximize the post-tax income and wealth of your family and you, which proper tax planning enables you to do. Therefore, merely choosing an option which minimizes your tax is not always the best option—another option may give you a better return even after paying taxes under that option. Also, spending money just to save tax without any other resultant benefits leaves you worse off.

Gautam Nayak is a chartered accountant.

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