We’re in January, and soon it will be the end of the financial year. In order to save taxes on income, we need to purchase qualified tax-saving investments and insurance products before March 31, 2020. The financial marketplace is full of thousands of options, and it’s often difficult to make up our minds about how to invest and insure.
Tax-planning is a year-long activity which requires care, attention to detail, and your time. It should ideally not be left for the year-end. Last-minute investment decisions can often be disastrous, because you do not have the time to carefully evaluate your options. So let’s take a look at some common mistakes that happen in this year-end, tax-saving rush, and what you can do to avoid them.
Not Knowing Your Tax Liabilities
Have you checked what your tax liabilities for 2019-20 are going to be? The first step to knowing your tax liabilities is knowing your total income and your income tax slab. Income is generated through various means – salary, business, interest from deposits, capital gains from the sale of stocks or mutual funds, gifts and awards, and so on. Where there is income, taxes may need to be paid, but not all income is taxable. So dig out your salary slips, and your bank and investment statements to calculate your tax liabilities. Speak to your office accountant or a tax advisor or use an online income tax calculator. Remember that gross income (income minus tax deductions) up to Rs. 500,000 is tax-free. Technically, you could go up to Rs. 540,000 without buying any tax-saver because you are eligible for a standard deduction of Rs. 40,000. Therefore, you now need to buy tax-saving instruments to bring down your gross income as close to Rs. 500,000 as possible to minimise your tax liabilities. So, for example, if your gross income is Rs. 510,000, you can buy a tax-saver worth Rs. 10,000 and avoid taxes completely. By over-investing in tax-saving instruments, you will impede your own finances. Once your tax-saving needs are taken care of, you could invest in regular investment such as deposits and mutual funds to achieve your other objectives.
Buying Life Insurance Without Checking Suitability
There are many ways to save taxes, and insurance is just one. For example, you save taxes by making voluntary contributions to your EPF account, or by paying rent or your children’s school tuition fees. Take stock of taxes you’ve already paid and then decide how much more you need to save. The traditional Indian way to save income tax is buying life insurance. However, a policy bought just for saving taxes could leave you without adequate life cover (which is dangerous for your family) and without acceptable investment returns (which is bad for your finances). Therefore, before you buy life insurance, assess the coverage your family needs. For example, a thumb rule is that the sum assured can be 10-20 times your current annual income, as this can protect your family’s finances in the event of your untimely death. If you’re a person with dependents and looking to buy your first life insurance policy, buying a term plan is advisable. This would be easier on your pockets and also free up your savings to be invested in more lucrative investments.
Not Knowing About Investment Lock-ins
All tax-saving investments have lock-ins, typically starting from three years. During the lock-in, the investment should not be liquidated because you’ll have to pay the tax deductions you had claimed by buying those investments. In case of life insurance policies, you may also suffer heavy losses for premature liquidation, especially if you buy endowment or cashback plans. Not all investments have lock-ins. For examples, equity investments and open-ended mutual funds can be bought and sold as per your convenience. Locked-in investments create problems any time you need cash urgently. Therefore, always read the fine print of your investment carefully to know how long your money is off-limits.
Not Knowing The Returns On Your Investment
Always insist on knowing the annual rate of return on your tax-saving instrument and verify it against publicly available information about that instrument. Sometimes, the rate of return is clearly advertised; sometimes it is market-linked and cannot be guaranteed. At other times, you’re “assured” of a lump-sum without being told what your returns will be. Whatever the return may be, it should compare favourably with other tax-savers. Your VPF contribution currently earns 8.65% per annum, tax-free. Your PPF contributions earn 7.9% per annum, also tax-free. Some of the best ELSS mutual funds have provided long-term returns of 10-15% per annum. All these options provide you tax relief under Section 80C. If your tax-saver cannot provide you this much, you should ask yourself why you’re buying it.
Only Saving Taxes & Not Investing
Tax planning is one of the many pillars of money management. But focussing only on tax savings will impede your wealth creation and you’ll struggle to accomplish your financial goals. A good tax savings plan should be accompanied by well-defined financial goals, wealth creation, availability of liquidity to tackle emergencies, and having adequate health and life insurance. Lastly, tax-planning should be a year-round activity and not focused only on the last quarter of the year. This will allow you more time to think your decisions through, and to spread out your investment payments. This will save you from the financial stress of trying to find the money for last-minute investments.
Signing Your Forms In A Hurry
Lastly, since you would be in a hurry to complete your tax-savings, you may be tempted to sign the investment forms without reading them or going through the terms and conditions, risks, lock-ins, and investment costs. Needless to say, this would be a folly. Always read what you’re signing on. When in doubt, ask an investment or insurance advisor. If necessary, delay your purchase till you have clarity.
The writer is CEO, BankBazaar.com, an online marketplace for credit cards, loans, credit tracker, and much more.