Savingwala

Tax-saving traps to avoid

January to March is the time when most people seek tax-saving options. So, it’s a busy time for finance companies trying to lure investors with tax-saving offers. But you had better be careful not to buy a flawed product in your desire to save tax. Here’s what you need to know about these taxing issues

The period between January and March is the busiest one for life insurance companies. Lakhs of insurance agents aggressively sell unit-linked insurance plans (ULIPs) with a bait of tax saving. Insurance companies come out with new campaigns during this period.

ICICI Prudential Life has roped in Amitabh Bachchan with the campaign ‘Jeene Ka License’. Future Generali has introduced ‘Insurance Week’ with the campaign ‘Sign karo, Mukti pao’. The brand new campaign for IDBI Federal’s Wealthsurance Milestone Plan, says ‘Jisne Bhi Suna, Khareed Liya’, with the baseline ‘Nahin suna toh SMS kijiye…’ Over half of the policies sold in the fiscal year are sold during this period specifically due to their tax savings lure. Without the tax exemption, few people will buy ULIPs. During the tax-saving season, people are so desperate to save Rs30,900 in taxes by investing their hard-earned Rs1 lakh in certain kinds of savings, that even the most risk-averse person starts taking risks. Maybe the tax-saved money confers a sense of security. So, investors easily walk into various traps. One such trap is laid by unwary and even trustworthy bankers.

If ULIPs are tricky products, why do people fall for them? That’s because these are advertised heavily and there are millions of agents nudging you to sign on the dotted line. Remember, you have many other options for saving tax. Under Section 80C of the Income-Tax Act, a deduction of up to Rs1 lakh is allowed from taxable income in respect of investments made in specified schemes (see box above). So how should you go about deciding what are the right tax-savings products for you?

Various tax-savings products have diverse features and they appeal to different people, depending on their age and income structure. In general, mutual funds and term policies are considered better options compared to ULIPs. But as Yogin Sabnis, a financial planner and managing director, VSK Financial Consultancy Services, says, “There cannot be a thumb rule for tax planning. It depends on individual cases. Some people will benefit from Public Provident Fund (PPF), some from term plans (if they are not insured) and so on. The product has to suit individual requirements. Equity-linked savings schemes (ELSS) of mutual funds are a popular product. But if someone already invests in stocks, then ELSS may not be a good option. Debt products may be a better option to balance the portfolio.”

Taxpayers often go in for ULIPs, unknowingly. Those who know better go for ELSS. But just as we say don’t mix investments and insurance (like in ULIPs), don’t put retirement funds or long-term savings into risk products just because you are running out of time for the 31st March deadline. To understand the importance of this, let’s look at a product which is an obvious winner: ELSS. Long-term capital appreciation and dividends from ELSS are tax-free.

Though this seems like an attractive investment option, be careful before you bite the bait. If you sink your funds into ELSS at the wrong time, your returns could be low. Your money is locked in for three years, irrespective of the performance of the market. As an investor, your status will be reduced to that of a mute spectator, despite the market plummeting—or worse, shooting up.  You can neither withdraw money to cut losses nor to book profits. The variation in performance is huge. Some ELSS have done poorly. Indeed, it would be silly if you were to lose a part of your principal simply because you are sharply focused on saving taxes. Equity investments should be carefully planned, using a systematic investment plan (SIP) or, even better, by a system of value averaging and maintaining a long-term view of the investment, beyond the three-year lock-in period.

Old Is Gold

So, how should you plan your investments for tax savings? First, remember your tax-savings instruments have to fit into your overall financial profile and complement your other investments. Second, be clear about what you want that investment to do for you—this partly depends on your age. Third, decide for how long you can leave that money to work for you. Once you are able to answer these three questions, the task of zeroing in on the right investment products becomes easier. Here are some pointers based on your age, and point of your life cycle.

Up to Your 30s: This is the time to buy a term insurance cover and also take advantage of long-term compounding of returns. If you have already taken a home loan, then your preferred tax-saving options should be the tax deduction you get towards the repayment of the principal amount up to Rs1 lakh and also interest paid.

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