INCOME TAX SPECIAL... LAST-MINUTE TAX PLANNING

LAST-MINUTE TAX PLANNING





Taxpayers often commit mistakes in the rush to save tax.

Find out how not to make errors you will later regret.

The month of March witnesses some of the worst financial mistakes as investors rush to make tax-saving investments. ELSS funds topped the ET Wealth ranking of best tax saving options earlier this year. However, though financial planners recommend sys tematic investing, less than 20% of the total in flows into ELSS funds come through the SIP route. Traditional life insurance plans don't yield more than 5-6% returns, yet sell like hot cakes in March. When it comes to the PPF, even young taxpayers don't mind locking up their money for the long term to earn modest returns.

How can taxpayers avoid such mistakes?

ELSS funds are equity schemes that help cre ate wealth in the long term. The category has generated 20.2% annualised returns in the past three years and 16.4% in the past five years. But one must invest through monthly SIPs, not put a huge amount at one go. This is especially true in the current situation when the markets are at high levels. If you intend to invest `50,000-60,000 under Sec 80C before 31 March, we would recommend that you put only `15,000-20,000 in ELSS and the rest in a safer option such as PPF or NSCs. You can in vest more in the ELSS fund in the new finan cial year, possibly through monthly SIPs.

Taxpayers should note that every invest ment option plays a certain role in the portfolio. They should choose investments that fill gaps in their portfolios.Invest in ELSS funds if you are looking for equity exposure.Also, choose an ELSS fund that matches your risk appetite.Funds with a larger exposure to small and mid-cap stocks may be more volatile than funds that have lined their portfolio with large-cap stocks (see graphic). Most importantly, the three-year lock-in period should not be construed as the holding period for an ELSS fund. Holding for longer periods could give better returns.

Similarly, the PPF is a good option for long-term savings.Though the PPF should be part of the debt portfolio, younger people should not over-invest in this option. In most cases, the monthly contribution to the Provident Fund is more than sufficient to build up the debt portion of an individual's investment portfolio. Adding the PPF could skew the asset allocation and drag down the overall returns.

NO MULTI-YEAR COMMITMENTS

The other big mistake is to make a multi-year commitment without fully understanding the implications. Life insurance policies require you to pay the premium year after year, for the full term of the plan. You can close a plan prematurely, but not without taking a hit. Insurance plans sell like hot cakes in March as taxpayers buy them for the wrong reasons (see story on page 5). One should avoid buying an insurance plan in a hurry. Assess your need for life insurance cover, your ability to service the premium for the full term and your willingness to accept 5-6% returns. If all the boxes are ticked, go ahead and buy the insurance plan. Otherwise, stay away from policies that combine the triple benefits of life insurance, investment and tax savings.

Ulips is another such multi-year investment. The new online Ulips are very different from the pre-2010 policies.Their costs are very low, which leads to higher returns for investors. Equity plans of Ulips have earned almost 12% annualised returns in the past five years. However, this number only denotes the growth in the NAV and the actual returns for the investor might be lower because some charges are levied by cancelling units. However, these policies also require multi-year commitments. Be sure you will be able to pay every year before you sign up.

The only insurance policy worth buying is a pure protection term plan. These plans only cover the risk of death and do not have a maturity value. As a result, these plans have very low premiums. A 30-year old non-smoker can buy a `1 crore life cover for as little as `7,500 a year.

SMALL SAVINGS BEST OPTION

If you don't have time to assess the utility of an insurance policy or go through the fine print, stick to the tried and tested small savings schemes. Though interest rates have come down in recent months, small savings scheme still offer 8-8.5%. The PPF offers 8% tax free, which makes it better than bank deposits where interest rates have slid to 7-7.5%. However, investors should be ready for rate cuts in the future. Now that elections are out of the way, the government may cut the rate on small saving schemes.

Another option is the Sukanya Samriddhi Yojana (SSY), but it is only open to parents with daughter below 10. Accounts can be opened at any post office or designated branches of PSU banks and select private banks with a minimum investment of `1,000. Every year you must invest at least `1,000 in the account. There is also an investment limit of `1.5 lakh in a financial year. You can open accounts for up to two girls but the combined limit cannot exceed `1.5 lakh. The account matures when the girl turns 21, though up to 50% of the corpus can be withdrawn after she is 18. The SSY offers a higher interest rate of 8.5% and enjoys the same tax benefits as the PPF.

But there are restrictions on withdrawals and a longer lock-in period. Like the PPF, the interest rate of the scheme might be cut in the future as interest rates come down.The bigger problem is that opening a Sukanya account may take up to 2-3 days and another 3-4 days for the cheque to reach the account. Many taxpayers may not be able to beat the 31 March deadline.

For senior citizen taxpayers, the Senior Citizens' Savings Scheme is the best tax-saving option. It offers 8.5% returns and the interest is paid out every quarter. The scheme is for five years and can be extended for a period of three years once it matures. The account can be opened in any post office branch and designated branches of PSU banks and select private banks.However, there is an investment limit of `15 lakh per individual. Investors who have already hit that limit should look at other taxsaving options such as PPF and NSCs. At 8%, NSCs offer close to 50-75 basis points more than what fixed deposits give. What's more, the interest earned on the NSC is also eligible for deduction under Sec 80C.

WHEN TIME IS RUNNING OUT

Five-year bank deposits score when the deadline is very close. They are perhaps the easiest way to save tax if you have a Netbanking account. You are not at the mercy of clock watchers in a post office branch, nor depend on a distributor. A few clicks of the mouse and your tax planning is complete.However, as mentioned earlier, this convenience comes at a very high cost. Interest rates have come down significantly and the best fixed deposit is offering 7.5%. The bigger problem is that the interest is fully taxable. It is added to the income of the investor and taxed at the marginal rate applicable to him.In the highest 30% tax bracket, the post-tax yield is close to 5%.

Keep in mind that the interest from such deposits will be subject to TDS if the total income exceeds `10,000 in a financial year.Don't be under the misconception that if TDS has been paid, you don't have to pay any tax. TDS rate is only 10% and if you fall in the 20% or 30% tax brackets, you have to pay additional tax.

Tax-saving fixed deposits are suitable for risk averse investors, especially senior citizens who might have already hit the `15 lakh ceiling in the Senior Citizens' Saving Scheme and don't want to lock money for the long term in a PPF account. Though NSCs offer higher rates, many senior citizens prefer to invest in deposits of their own banks because they get better service than in a post office. Also, familiarity with bank staff is an important factor for such individuals.

NOT TAX SAVING ALONE

Some experts say that tax savings should not be the only reason to invest in a particular instrument. The National Pension System (NPS) has generated a lot of interest among taxpayers after the introduction of the additional tax deduction of `50,000 under the new Sec 80CCD(1b). However, the NPS is a retirement product and locks up money for the very long term. If you are 30, the investment will mature in at least 28-30 years. Even then, only 40% of the corpus will be tax free. Another 40% will have to be put in an annuity to earn pension that will be taxed as income.

Financial experts also say it is better to pay tax than invest in the NPS to claim tax benefits. Their logic: NPS has a restrictive investment mandate and is not likely to match the returns of equity funds. They are correct only when the NPS is compared to equity funds. But when compared to debt instruments such as NSCs and bank fixed deposits, the NPS is certainly a better investment option.

ETW14MAR17