Last minute investment decisions to save taxes increase the possibility of making less than optimal investment decisions. Instead, investors should review their financial position, financial goals and likely tax liability early in the new fiscal year and plan their tax saving investments based on their financial goals, risk tolerance and asset allocation strategy.
In FY 2021-22, here are a few tax planning steps to improve financial health:
Consider mandatory payments, investments, and annual income when estimating tax deductions
The repayment of interest and major components of home loans, employee contribution to EPF, house rent and educational costs for children are inevitable. and also qualify for tax withholding under various sections of the Income Tax Act. Therefore, investors should first make a rough estimate of their unavoidable expenses or contributions, which are also tax deductible. This would save them from over- or under-investing in tax-saving instruments.
While underinvestment can increase your tax liability, overinvestment would unnecessarily jeopardize your liquidity by freezing your funds in instruments with longer lock-up periods when similar but non-tax-saving instruments were available in the same asset class without a lock-up period. in periods.
Calculate and compare the tax liability according to the old and new tax regimes
The 2020 Union budget introduced a new tax system with lower tax rates to reduce the tax liability of taxpayers who are unable to benefit from various tax deductions and tax exemptions available under the old tax system. This new regime is optional and taxpayers can continue the old tax regime if they so choose. Those who opt for the new regime should note that they will have to forego numerous deductions and exemptions available under the old tax regime.
Taxpayers, especially those who need to share their likely tax saving investment with their employers early in the fiscal year, should use online tax calculators to calculate tax liability in both regimes and then opt for the one that results in the lowest tax liability.
Don’t limit your tax savings portfolio to fixed income instruments
The risk aversion of a significant part of taxpayers prevents them from investing in equity-based instruments like ELSS, NPS or ULIP, even if they offer higher returns than tax-saving fixed income products like PPF, VPF, tax savings, NSC etc. in the long run. Given that stocks tend to outperform fixed income instruments and inflation well over the long term, ELSS and equity-based plans in NPS and ULIPs have the potential to build larger corpuses for their long-term financial goals.
In addition, the three-year vesting period at ELSS is one of the shortest of all tax-saving investment options and offers a higher degree of liquidity compared to conventional fixed-income tax-saving instruments. Investors should therefore carefully weigh their risk appetite, their investment horizon and their asset allocation strategy and choose their tax-saving investment accordingly.
Use the SIP investment mode to spread tax investments over the year
Many taxpayers who invest in ELSS to save on Section 80C taxes tend to delay their tax saving investments in the hopes of investing during market corrections or bearish periods. However, this strategy can backfire if the stock market continues its uptrend until the end of the fiscal year without any major drops or corrections. Investors would then be forced to invest in ELSS at a higher level towards the end of the financial year.
Investors should therefore opt for the SIP mode for investments in ELSS and spread their tax savings in ELSS over the entire financial year. In this way, they can average their investments in the event of corrections, if any. In the event of a strong correction or a declining market phase, investors can top up their ELSS-SIP at any time with lump-sum investments and either stop or stop the ELSS-SIP for this financial year as soon as the targeted tax savings have been achieved.
Don’t mix insurance with investment
Many taxpayers tend to make the mistake of mistaking insurance for investments, and therefore invest in foundation and money-back policies, which not only offer inadequate coverage, but also produce sub-optimal returns and have low liquidity characteristics.
Since the main purpose of taking out life insurance is to provide your family with a replacement income in the event of your premature death, make sure that your life insurance coverage is at least 10-15 times your annual income. The best insurance product for buying such large life insurance policies at very low premiums is term insurance. For long-term wealth creation, investors should choose ELSS as they offer greater liquidity and a wider range of products to suit different risk appetite and investment philosophies.
The author, Sahil Arora, is a director at Paisabazaar.com. The views expressed are personal