Money saved is equal to Money earned. The salaried individual has an innate understanding of this phrase as he tries to minimize his tax outgo to the maximum extent possible, but that is easier said than done. Let’s learn about 5 mistakes to avoid when choosing tax-saving products.
Also read: 5 Common Financial Mistakes Every Investor Should Avoid
Tax Saving Investments
Ideally one should formulate his tax saving strategy at the beginning of the financial year and then invest accordingly throughout the year. However, most taxpayers omit to do the same and think of tax saving only in the last quarter when their company starts asking for proof of investment for the financial year, which is usually the December-January period.
This last-minute scramble to avoid taxes sometimes leads to investment decisions that are faulty and hence very costly, working against the tax-saving efforts of the salaried individual.
Tax-saving investments in the wrong products in the last-minute rush have to be avoided to ensure long-term wealth creation from a well-diversified portfolio. Nonetheless, if you are amongst the many who are struggling to complete your tax planning process before the deadline, here are some common mistakes to avoid while choosing tax-saving products
1. Investing in Insurance Endowment Plans
When an individual taxpayer walks into a bank and pursues the help of its executives, he will more often than not be sold an endowment insurance plan. This product offers the bank executive 30-35% of the first year’s premium and 5% of the subsequent years’ as commission while the investor earns a paltry 6-7% per year, that too only if he pays the premium for the full term.
What he fails to realize is that endowment plans are long-term products, having a maturity period of 10-20 years. If he pays the premium for only 5 years and then redeems the investment, he will get less than the principal amount. He also may not know that a major part of the premium paid by him goes towards mortality charges and distributor commission.
To avoid this pitfall, one should avoid endowment plans as a tax-saving tool and instead invest in simple plans such as that of a PPF or tax-saving mutual fund which give tax-free returns. Alternatively, one can purchase a term plan whose premium is eligible for a tax deduction.
2. Holding too Many Life Insurance Policies
Many taxpayers, to claim deductions under Section 80C, purchase life insurance policies. However, as the salary increases for the individual, he realizes that he needs to invest more to reduce his tax outflow. The easiest way to do this seems to be to purchase another life insurance policy.
In an attempt to make tax-saving investments, one may end with too many policies with varied covers and clauses which is uneconomical and may not even suit the needs of the insured. A single policy is usually more efficient.
One should have a term policy with a cover that is 5 to 8 times one’s annual income. This can be topped up in case the family expands or one takes on larger liabilities such as a home loan.
3. Investing too Much in Fixed Deposits and National Saving Certificates
A common last-minute strategy for making tax-saving investments is to invest in 5-year Fixed Deposit Schemes or National Savings Certificates. The interest earned through investment in both these products is taxed as per the tax slab within which the individual falls. Also, the interest earned on the tax-saving FDs is less than that earned on regular FDs. The ultimate post-tax return from these products is less than the inflation rate making this an unattractive option.
4. Omitting Investment in Health Insurance
In an attempt to claim deductions under section 80 C of the Income Tax Act, one often holds multiple life insurance policies but omits purchasing a medical cover beyond the group insurance policy of the company. It is important to realize that medical insurance coverage given by the company will lapse once one leaves the company and so one must purchase the policy on an individual basis.
Secondly, medical covers are supplementary by nature. Hence the private policy can provide a cover in addition to the one provided by the company.
Most importantly, a medical insurance premium is deductible under Section 80D of the Income Tax Act, over and above Section 80C. One can claim a premium reduction of up to Rs. 15000 for spouse, self, and children and an additional Rs. 20,000 for senior citizen parents, which leads to tax savings of up to Rs. 35,000.
5. Investing In Products You Are Not Qualified For
Before selecting a tax-saving investment one has to verify that one is eligible for the tax-related exemptions. For Instance, under the Rajiv Gandhi Equity Savings Scheme (RGESS), an individual can avail of the tax saving benefits only if he is a first-time equity investor. Similarly for claiming tax deductions on home loans, if the house bought by the taxpayer is under construction, the interest paid on the loan can be claimed only in 5 equal installments, immediately following the year where you get possession of the property.
These are some of the common mistakes that are repeated too often by taxpayers while looking for tax-saving investment opportunities. Additionally, sometimes in the last-minute scramble to make investments and save tax one commits to plans that require long-term and regular contributions. For example, life insurance policies require regular premium payments each year. Similarly, for PPFs, the minimum tenor is 15 years and if one misses a payment, a penalty has to be paid.
Similarly, many times one also oversees the mode in which the payment has to be made to claim tax deductions. For example, in the case of health insurance, the premium should be paid online for it to be considered eligible for a tax deduction.
Another pitfall is limiting oneself to the deductions available under Section 80C and not looking into the ones available under Section 80D and 80G.
It is essential to avoid these tax-saving traps to make the best use of these income tax deductions and enable long-term wealth creation through prudent tax-saving investment decisions.
