You are bombarded with emails, messages and advertisements urging you to act fast to save tax with tax saving investments. In this rush to make to save tax, are you making the right choice of tax-saving investments?
It is not uncommon for people to scratch their heads some years after making tax saving investments not knowing what to do with them for tax saving was long done and dusted. Sure, tax saving investments, eligible for annual tax deductions of Rs 1.5 lakh under Section 80C, help save substantial amount of income tax. However, most people end up only doing just that—save tax.
It need not be that way. While essential for your tax planning, tax saving investments can play a major role in achieving your major financial goals, be it your child’s higher education or your retirement. So, how can you achieve more from your tax saving investments? The key lies in understanding their four important aspects.
Long-term nature Most tax saving investments tend to be long-term investments products whose tenure or term typically range from 10-30 years whether it is 15 years for Public Provident Fund (PPF) to 10-30 years for unit linked insurance plans (ULIPs). This makes these investments ideal for meeting long-term needs. So, if you are investing for long-term goals, tax-saving investments can find a place in the mix of investments. Thus, for your child’s higher education, you can have a mix of both PPF and ULIP.
Lock-in period and premature exit penalties A major reason that tax-saving investments require due consideration is the different lock-in periods involved with each one of them. They typically range from 3-6 years, or more. Further, premature exits often involve significant penalties. In some cases, only partial withdrawals are allowed.
Varying investment risks You have lower risk tax-saving investments such as PPF, National Savings Certificate (NSC), notified bank fixed deposits (FD) and certain types of life insurance endowment plans as well as higher risk, equity-oriented investments such as equity-oriented funds of ULIPs. Since equities typically provide high returns in the long-term i.e. 8-10 years or more, ULIPs can be a great vehicle for combining tax savings with potentially high growth.
Tax treatment for returns and maturity proceeds Investments eligible for annual tax deduction under Section 80C have varying tax treatments for returns and maturity proceeds. For instance, interest is taxable for notified bank FDs while investments in Equity Linked Savings Schemes (ELSS) after the three year lock in need to pay long-term capital gains tax of 10% without any indexation benefit for capital gains in excess of Rs 1 lakh. On the other hand, for life insurance plans, maturity proceeds are tax free under Section 10(10)D.
Making the most of tax saving investments The four key aspects of tax saving investments indicate a few things to us. While making tax-saving investments, you need to first find out the amount of tax saving investments you need to make. Remember, you might already have annual commitments to existing tax saving investments.
Next, you need to earmark a tax-saving investment to an important long-term financial goal. Even as you do it, you need to be mindful of the term and lock-in period since the money should be available when you need it. While selecting the investment, you need to be mindful of the investment risk as well as tax treatment. This will ensure maximum savings for your different long-term needs. That way you get your money to grow and take you the whole distance to your cherished dreams, and not just save tax.
