Sync tax investments with financial goals
Buying the wrong tax-saving product, then abandoning it after a year or two because you realize it isn’t suitable, will harm your financial health.
With just four-and-a-half months left for the financial year to end, it is time you began making tax-saving investments — if you haven’t already. And when you invest in these instruments, make sure that they are in sync with your overall financial plan, and help you move closer to your financial goals. Random, one-off investments in products selected without due care can do a lot of harm to your financial health.
Fulfil your insurance needs first: To decide where to invest for tax saving, examine the gaps in your financial plan. First, check if you are adequately insured. The tax benefit is available on life insurance (Section 80C) and health cover (Section 80D).
The broad principle for deciding whether you have adequate life cover is: your existing assets plus your life cover should be adequate to meet all your liabilities, provide for major financial goals, and for your family’s regular needs. If you find this too complicated, go by a simplistic rule of thumb and buy a term plan with sum assured equal to 10-15 times your annual income (depending on what your pocket allows).“Avoid investment plus insurance products. With term insurance, you will be able to get relatively higher sum assured at a lower premium.”
Next, assess your health insurance coverage. Even if you have a cover from your employer, buy personal health cover for your family.Match investment product to risk appetite: Before you start investing, check to what extent your existing investments and expenses will fulfil your Section 80 C obligations. For instance, you may have Employees’ Provident Fund (EPF) contributions, life insurance premium, and principal repayment on home loan. In that case, you may have to invest only a limited amount.
Most products on which you get tax benefit under Section 80C are debt products, barring two unit-linked insurance plans (Ulips) and equity-linked saving schemes (ELSS)* which are equity products. Choose an equity or debt products depending on the asset allocation of your existing portfolio. On the equity side, prefer ELSS. “Be aware of your risk tolerance before investing in ELSS. To realize higher returns, you should be prepared to stay invested for a relatively long period of more than five years in ELSS,” Public Provident Fund (PPF), which gives tax benefit at the time of investing and is tax free upon maturity, should be favored on the debt side.
*We at MEGA suggestbest ELSS schemes; for more information feel free to Contact: firstname.lastname@example.org
Ulips are for the young: According to Insurance Regulatory and Development Authority of India (IRDAI) rules, if you are less than 45 years old the sum assured on your Ulip must be at least 10 times the premium. But if you are above 45, the minimum sum assured can be only seven times Income tax rules, however, say that maturity proceeds will be tax exempt only if the sum assured is 10 times the annual premium.“Older investors need to ensure that they buy a Ulip that meets this criterion.”
While younger investors may buy a Ulip, older investors should avoid them. “A Ulip is an investment-cum-insurance product. A part of your premium goes into meeting mortality cost. This cost is lower for younger persons, hence Ulips may not be a bad idea for them. But it increases as you grow older and affects the returns of these investors.”
Steer clear of mis-selling in traditional plans: This is the product category that is most heavily mis-sold during the tax season. These plans invest heavily in government and other bonds. Commissions to agents also tend to be high in the initial years.
So, the internal rate of return on them does not exceed 3-6 per cent. Moreover, exiting them is difficult. An investor loses out on all his money unless he has paid the premium for at least three years. Here again the rate of return tends to be lower for older persons due to higher mortality charges.
Key mistakes to avoid
Individuals often postpone tax planning till the end of the financial year. As the deadline (usually the first half of February) for showing proof of investments draws near, they invest randomly in any product that will help them save tax for that year. Later, they realize that it is not suited for them, so they abandon it. For many investors, this sequence of events gets repeated several times, at least in the initial years of their working life. Tax planning should not be a standalone, one-off activity but should be in sync with your overall financial plan.“All tax planning decisions should be taken keeping in mind three major aspects – your personal financial goals, risk tolerance and investment horizon.”
Many investors over-invest in tax-saving products. “Due to sales push by agents during the tax-saving season, many people buy multiple insurance policies even though their Section 80C limit has already been reached.”
Many investors also fail to appreciate that some products give tax benefit at the time of investing and are also not taxed at maturity. Public Provident Fund (PPF) belongs to this category. On the other hand, products like the five-year fixed deposit gives tax benefit at the time of investing, but the interest income from it is taxable. The former is obviously a superior product. Many people also do not realize that the interest income from the National Saving Certificate (NSC) is taxable. Others are not aware of the additional tax deduction of Rs 50,000 available on National Pension System (over and above Section 80C), or that tax benefits are available only if you invest in a tier one plan.
Some investors rotate their tax savings. They pull money out of those instruments whose lock-in has ended and reinvest it again for tax-saving purpose. “If they were to let the money remain invested and put in new money each year, it would help them create a considerable corpus over the long term.”
Term plan, EPF, PPF and ELSS should be your favored instruments for meeting your Section 80C requirements. Risk-averse investors looking for better returns may also opt for retirement products from mutual funds, which are hybrid funds with a lock-in of five years.
Courtesy: Business Standard Date: -26 Nov 2018(Sanjay Kumar Singh)