Investing is serious business, and you need to study a financial product in detail before you put money in it. More importantly, tax-saving investments should be part of the overall financial plan of the individual. Invest in ELSS funds if your portfolio requires equity exposure. Buy an insurance policy if you need life cover. Pour money into NPS if saving for retirement. Go for PPF if you need to invest in fixed income for the long term. Invest in NSCs or tax-saving fixed deposits if you need the money back soon. “Your tax-saving investments should be in sync with your long-term investment objectives,” says Amit Maheshwari, Tax Partner at tax consulting firm AKM Global.
Choose investments that fit your needs
Besides saving tax, all these instruments fulfil specific needs in the financial portfolio.
But it is not possible to assess the suitability of an investment if you crunch your tax planning into a few weeks of the financial year. For instance, ELSS funds have become popular among taxpayers in the past 10 years, but you have to zero in on the most promising scheme. There is a very wide variation in the performance of ELSS schemes. In the past three years, the best performer Quant Tax Plan has moved at a scorching pace of 38.27%, while the worst performer Aditya Birla Sun Life Tax Relief 96 has risen at a snail’s pace of 9.41%. The difference is too stark in absolute terms. Someone who put Rs 1 lakh in Quant Tax Plan in April 2019 has seen his investment more than double to Rs 2.64 lakh in three years, while an investor in Aditya Birla Sun Life Tax Relief 96 is sitting with merely Rs 1.3 lakh.
The other problem is that last-minute tax planning loses the SIP advantage. ELSS funds are equity schemes and carry the same risks as any equity fund. In fact, the risk is greater because you cannot exit before three years. Jaipur-based Roshan Aswani (see picture) has been investing in ELSS funds for equity exposure. ELSS funds account for almost 40% of his equity portfolio. Some of these investments are almost 10-12 years old. “The lock-in is long over, but I haven’t withdrawn from these schemes because my portfolio needs equity exposure. I want to remain invested for the long term,” he says.
Roshan Aswani, 39 years, Jaipur
Has been investing in ELSS funds for the past 10 years to save tax. He does not redeem the funds even after the lock-in period has ended because he considers the ELSS funds as the equity portion of his overall portfolio.
“ELSS are equity schemes, so I want to remain invested for the long term.”
Don’t buy insurance in haste
ELSS funds have a very short lock-in period of three years. They also do not force investors to continue investing if they aren’t satisfied by the returns. But life insurance policies are a different ball game. A life insurance policy is supposed to cover the risk of early death and safeguard the financial goals of the individual in case something untoward happens to him. Buying a policy without understanding its features or assessing the extent of the coverage you need is the worst way to take life insurance. Yet, lakhs of insurance policies are sold in February-March, with buyers signing blindly at specified places in the application form.
When buying life insurance, assess how much insurance you need. A thumb rule is to buy a cover of at least 8-10 times your annual income plus any large borrowing. For someone with a salary of Rs 1 lakh per month, that adds up to a life insurance cover of around Rs 1-1.2 crore. Add to that an outstanding loan of Rs 30 lakh and the total insurance required is Rs 1.5 crore. It is unlikely that the insurance policies hawked by agents and bank representatives can offer such a huge cover without pushing the premium into the stratosphere. But a term insurance policy can provide a cover of Rs 1.5 crore to a 30-year-old person for as little as Rs 12,000 a year. No bank representative will suggest a term cover, and no agent will try to sell you one because the commission is very low.
The change in tax rules for the Provident Fund has robbed high-income earners of a lucrative tax-free avenue. Such investors should consider putting money in Ulips where the income will be tax-free if the premium is less than Rs 2.5 lakh a year. But buy a Ulip only if you already have enough life insurance, and can continue with the policy for the full term. Most importantly, understand the charges and the features of the policy before signing up.
Just like life insurance, you also need to understand in detail the features of your health plan. Check out the exclusions and the limits in your plan, and the extent of the coverage it provides. Unfortunately, many buyers look at health insurance from the perspective of tax deduction and buy a cover with a premium of Rs 25,000 only. But in the past two years, many buyers have realized that a medical cover of Rs 3-5 lakh can be woefully inadequate.
Fixed income investments
Investors who do not have a high-risk appetite should consider fixed income instruments for their tax planning. The PPF is a terrific instrument loaded with several benefits. Given the liquidity it provides, taxpayers like Kolkata-based chartered accountant Tilotama Gourisaria use the PPF as an emergency fund from which they can withdraw in case of an urgent need.
Tilotama Gourisaria, 35 years, Kolkata
Has been contributing to the PPF for the past 12 years and has built up a sizeable corpus. Though concerned by the fall in the PPF interest rate, she continues to stick with it because of the exempt-exempt-exempt status.
“Although I started investing in PPF to save tax, it is now my emergency fund.”
While ELSS investments should be staggered in monthly SIPs, it is better to invest in fixed income options at one go. This may not always be possible given the cash flow of the salaried household. Still, invest as much as possible early in the year to gain from compounding. When investing in PPF, make sure you do so before the 5th of the month so that you don’t miss that month’s interest.
Saving for retirement
Many tax-saving instruments are geared for long-term savings. The NPS can reduce tax in three ways. Contributions to the NPS are covered under the overall deduction of Rs 1.5 lakh under Section 80C. If a taxpayer has already exhausted this limit, he can avail of the additional deduction of Rs 50,000 under Section 80CCD(1b). The last one is a super tax saver. If the employer puts up to 10% of the basic salary of the individual in the NPS, that amount will not be taxable.
How NPS funds have performed
Average returns of the four categories of NPS funds.
For example, a taxpayer with a basic salary of Rs 1 lakh can opt to put Rs 10,000 in the NPS every month (Rs 1.2 lakh per year). This can reduce his tax by almost Rs 37,500 per year. NPS can also be used by self-employed taxpayers like Anil Jajoo to reduce tax. He uses the low-cost scheme to save for retirement and reduce his tax and plans to shift his superannuation fund from his previous employer to the NPS. “The ultra-low costs of the NPS help deliver higher returns than what mutual funds can give,” he says.
Anil Jajoo, 53 years, Ghaziabad
He quit his job four years ago and has been using the NPS to fatten his retirement corpus. Jajoo puts Rs 50,000 in the scheme every year and plans to shift his superannuation fund from previous employer to the NPS.
“The low costs of the NPS help deliver higher returns than what mutual funds can give.”