Mistakes To Avoid Before Making Tax Saving Investments

We have entered March 2021 and soon we will be celebrating our 1 year lockdown anniversary. It Maybe not so much of a celebration but still, we have survived 1 year of COVID with some gains and some losses, and lots of learnings. Another reason to look forward to March 2021, is the last month to make all your tax-saving investments!

Choosing tax regime without comparing liability The finance ministry in the previous financial year 2020 had introduced a new tax regime that gives individual taxpayers the option to pay income tax at a concessional rate.
Read more about old regime vs new regime

Notably, if you opt for the new tax regime with lower tax rates, you will have to forego the deductions and exemptions including the standard deduction, deduction under Section 80C, interest paid on housing loan, etc. This can be helpful if you do not want to lock-in your funds for a longer period in tax-saving instruments such as Tax Saving Bank FD, Provident Fund, etc.

Comparing liability under the existing and the new tax regime while helping you to decide on the most suitable option depending on your income and expenses and customize your investment preferences accordingly.

1. Failing to ascertain actual taxable income

When computing the taxable income, it is important to take into account all sources of income. Besides the income from salary, you may have income from a business, rental income from property, interest from bank/post office deposits, capital gains from assets, or any other source.

Determining the taxable income is an important step in streamlining your tax planning exercise which will help you to correctly estimate the amount of tax-saving investment to be made for reducing your tax liability.

2. Taking the wrong approach to insurance

The primary purpose of a life insurance policy is to provide financial protection to dependents in case of the untimely demise of the insured person. Simply opting for a policy because it offers a tax deduction under Section 80C of the Income Tax Act, 1961 is an imprudent approach.

There is a possibility that you may end up investing in investment cum insurance policies such as endowment policies, money back plans, or ULIPs that provide tax-saving components along with life cover in a bid to meet tax-saving requirements. However, you must know that these products will neither provide adequate cover nor generate optimal returns. A simple-term plan is enough to take care of your life insurance requirement at a very reasonable premium. Read this article to compute how much cover should you have

3. Not aligning your Investments as per your goals and investment objective

Ensure that you are not investing in 80C investment options only for tax savings purposes. Check how it fits into your debt - equity allocation which is determined based on your risk profile. Further, these investments should be made to achieve your goals not just for the purpose of tax savings. Align them to your requirements. Do not just invest in 80C investment options, if you have already exhausted this limit, you can explore options beyond Section 80C. Besides, certain payments that are eligible for deductions such as payment of house rent, expenses towards children's school tuition fee, interest payment on the home loan.

Read these articles to know more about your tax planning before March 2021
1. How to save taxes before you invest your money.
2. Ways to save taxes under various sections of the Income-tax Act.
3. Mutual Fund taxation
4. How to save taxes on health insurance

Disclaimer: - The articles are for information purposes only. Information presented is general information that does not take into account your individual circumstances, financial situation, or needs, nor does it present a personalized recommendation to you. You must consult a financial advisor who understands your specific circumstances and situation before taking an investment decision.

Equity Linked Savings Scheme (ELSS) - Everything you need to know

ELSS or Equity Linked Savings Scheme is a dedicated mutual fund scheme which helps you save tax. When you invest your money into a mutual fund - ELSS scheme, you get a deduction under section 80C of the Income-tax Act, 1961 of an amount up to INR 1,50,000.

An ELSS fund manager invests in a diversified portfolio, predominantly consisting of equity and equity related instruments that carry high-risk and have the potential to deliver high returns. Hence, ELSS is an equity mutual fund bearing similar risks and returns.

1. Lock-In period of ELSS of 3 years and more.

You have to stay invested for 3 years into an ELSS fund to continue the benefit of tax savings. However, many people believe that after 3 years you have to sell the ELSS. This is not true. You can stay invested for as long as you prefer based on your goals and market movements. There is no upper limit. In fact, if you want you can sell your ELSS before 3 years as well, you just have to bear the penalty and pay the tax you saved by investing in ELSS in the first place.

In fact, compared to other 80C investment options available, ELSS has the least waiting period. Like PPF has 15 years, the fixed deposit has 5 years and ELSS has only 3 years.

2. You can invest more than INR 1,50,000 into ELSS

Given that ELSS is an 80C investment option, many people assume that only INR 150,000 can be invested in any ELSS scheme. You can invest a minimum of INR 500 and maximum of anything into ELSS (like any other mutual fund).

3. It gives a higher return and hence, higher risk

ELSS are equity-based mutual funds and hence, the return on the same is higher. High returns mean higher risks. There is a good possibility that at the end of 3 years, there are negative returns in ELSS. As we have always said, equity investments are for long term goals and you must stay invested in equity for at least 7 years to avoid the risk of nil or negative returns. Countless studies prove that one can beat volatility and make superior returns from stocks by staying invested for a long period. You should remind yourself that equity has the potential to offer superior returns than other asset classes over a long period.

4. Growth or Dividend - ELSS Fund

If you choose the Growth option it ensures compounding your capital in the mutual fund investments. The final amount can be redeemed once at the end of the lock-in period.

But, the dividend option gives you some amount for various periods of time. It offers some liquidity even during the lock-in period. This dividend paid out can be further invested in other mutual funds depending on the investor’s portfolio or re-invested back into ELSS Fund.

The dividend received by the investors from these mutual funds is tax-free in the hands of the investors.

5. The tax of ELSS mutual funds

ELSS funds are equity mutual funds. Capital gain tax on ELSS funds is the same as in equity mutual funds.

If you sell your equity mutual funds after a year, the returns will qualify for long-term capital gains a tax (LTCG).

Investors will have to pay 10 % tax on profit gains exceeding ₹ 1 lakh made from the sale of stocks or equity oriented mutual fund schemes held for over one year. If you sell your equity mutual funds before a year, you will have to pay short-term capital gains tax of 15 percent on your returns.

Hence, ELSS helps you to save taxes by allowing a deduction of 1,50,000 but they are themselves not a tax-free product and returns from ELSS are taxable exceeding 1 lakh INR.

Wealth Cafe tip - Do not just look at the returns and invest in ELSS, invest with the same mindset in ELSS as you would in any other mutual fund. Also, do not just sell ELSS after 3 years. Sell them only when your goals for which you investing in ELSS is achieved or reaching near.