How to choose the best tax-saving investments

Individuals often postpone tax planning till the end of the financial year.
As the deadline for showing proof of investments draws near, they invest randomly in any product that will help them save tax for that year.
Later, they realise that it is not suited for them, so they abandon it.
Tax planning should not be a standalone, one-off activity, but should be in sync with your overall financial plan, says Sanjay Kumar Singh.

With just three-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 to 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," says Archit Gupta, founder and CEO, ClearTax.

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 80C obligations.

For instance, you may have Employees Provident Fund 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 product 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 realise higher returns, you should be prepared to stay invested for a relatively long period of more than five years in ELSS," says Gupta.

Public Provident Fund (PPF), which gives tax benefit at the time of investing and is tax free upon maturity, should be favoured on the debt side.

Ulips are for the young:

According to IRDAI (Insurance Regulatory and Development Authority of India) 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," says Deepesh Raghaw, founder, PersonalFinancePlan.in, a Sebi-registered investment advisor.

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," says Raghaw.

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 to 6 per cent. Moreover, exiting them is difficult.

An investor loses out on all her/his money unless s/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 realise 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," says Gupta.

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," says Malhar Majumder, founder, Positive Vibes Consulting and Advisory.

Many investors also fail to appreciate that some products give tax benefit at the time of investing and are also not taxed at maturity.

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 realise 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," says Majumder.

Term plan, EPF, PPF and ELSS should be your favoured 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.

Heed these changes in the last Budget

•Rs 40,000: A standard deduction of Rs 40,000 was introduced that replaces medical reimbursement and transport allowance. Saving of up to Rs 5,800 for salaried individuals.

•Rs 50,000: Under Section 80D, taxpayer can claim enhanced deduction up to Rs 50,000 (earlier Rs 30,000) on premium paid for a senior citizen. Claim additional deduction of up to Rs 20,000 by taking a medical cover for senior citizen parents.

•Rs 50,000: Senior citizens can, from April 1, 2018 claim deduction under Section 80TTB up to Rs 50,000 on interest received from deposits with banks and post offices. Gift money to your parents for investment in bank deposits. Gifts to relatives is tax exempt.

Interest income received by senior citizen parents will also be tax free up to Rs 50,000.

•Rs 100,000: Long-term capital gains on sale of listed equity shares and units of mutual funds, which were earlier completely exempt from income tax will, from April 1, 2018, be subject to capital gains tax at 10 per cent for gains above of Rs 100,000.