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Investors must purchase a policy only to ensure adequate risk coverage

Less than two months remains for people to invest wisely and save some taxes before the financial year ends on March 31. Although tax-planning should be done at the start of the financial year, the reality is that most people prefer to invest during the last three months of January, February and March -or JFM months -when it becomes absolutely necessary to act. Financial planners say that, although most people go for tax-saving options which are most convenient to them, ideally each should plan their tax-saving investments keeping in mind some specific factors like age, income level, risk-taking ability and financial goals.

 There should not be a one-plansuits-all approach here. It’s even better if the annual tax-saving plan becomes an integral part of an individual’s financial planning exercise. The two other articles on this page will give you some idea about the various investment options to save on taxes.Here, we will discuss the advantages of some of the investment options, which ones score over the others and how, and some common tax-planning mistakes that you can avoid. One very important thing to note here is that since the last Budget in July 2014, people have the option to invest up to Rs 1.5 lakh each year in tax-saving instruments, up from Rs 1 lakh earlier. FDs are highly tax-inefficient The popular investment options for taxsaving are equity-linked savings schemes (ELSS) from mutual fund houses, public provident fund, life insurance policies, pension plans, Rajiv Gandhi Equity Savings Scheme (RGESS) and select fixed deposits with banks.

According to Tarun Birani, founder and CEO, TBNG Capital Advisors, a survey revealed that nearly 56% of total household savings are parked in taxsaving fixed deposit schemes where the money has to be parked for at least five years. "However, FDs are highly taxinefficient products since the entire interest earned is taxed as income at the rate applicable to the investor every year," Birani said. "One of the prospective clients I met was invested in a 10-year cumulative fixed deposit from April 2013. On maturity in April 2023, he is eligible to get the principal and cumulative interest earned, but he was paying tax on the interest component every year," Birani said.

Logically, since FD rates match the rate of inflation in the economy, these instruments at best preserve investors’ purchasing power but do not help in creating wealth in the long run. On a post-tax basis, investors end up with negative real returns. These instruments, however, offer guaranteed returns to investors. ELSS are market-linked tax-saving mutual fund plans which come with a three-year lock-in -the shortest lock-in among all the tax-saving instruments available in the market. But there’s a risk caveat financial advisers repeatedly stress on for this instrument for most investors."These are one of the best investment avenues that investors should consider, provided their risk profile matches the risks associated with investing in ELSS plans," Birani said. Compared to ELSS and bank fixed de posits, PPF has an effective lock-in of seven years.In insurance, most products other than term plans that qualify for tax sops require the buyer to pay premiums for at least three or five years, else heshe will lose the entire premium and not get any return on the previous years’ payments.

Tax-planning mistakes

According to Nitin Vyakaranam, Arthayantra.com, not differentiating between investment and non-investment related products under section 80C is one of the biggest mistakes people make. "Savings under section 80C can be broadly classified as investment-based, like PPF, EPF, VPF, NSC, bank FDs, ELSS, RGESS, etc, and non-investment based like principal repayment of home loan on first home, tuition fees, insurance, etc. Though not an investment, insur ance is often considered as a long term investment and remains a preferred tax-saving instrument. One should refrain from buying unnecessary insurance products for the purpose of tax savings," Vyakaranam said.

"The purpose for taking insurance cover should be to ensure adequate risk coverage, not tax savings." Another common mistake is not understanding the benefits of section 80C in totality. "We often ignore the various contributions that can account for deductions in this section. The investments under 80C should only be made after assessing contribution to one’s provident fund account, home loan principal payment and tuition fees of two children, etc," Vyakaranam said.