4 crucial checkpoints to detect the correct tax saving investments

Making last minute decisions on tax saving enhances the chances of opting for sub optimal investment instruments. Instead, you must evaluate your financial goals, financial position, and estimated tax liability and strategically avail tax saving instruments according to your financial goals, asset allocation strategy and risk appetite. Note that there are various investment options like NPS (National Pension System)mutual fund investment in ELSS funds, PF contributions, etc. that qualify for tax deductions. Investing in such instruments make you eligible to avail tax deductions and exemptions through different sections of the Income Tax Act, to help you lower your tax liability.

Here are 4 crucial checkpoints that can assist you filter out and choose the correct tax saving instruments as per your financial requirements:    

       Factor in mandatory payments, annual income, investments while estimating the tax deductions

Interest and principal constituent repayment of home loan, home rent, employees’ contribution towards EPF and ward’s higher education expenses are unavoidable expenditures, which also qualify for deductions as per different Income Tax Act sections. Thus, you must first form a basic estimate about your unavoidable expenditures or crucial contributions towards investments that already qualify for tax deductions. Doing this can save you from over or under investing in any tax saving option. While under investing enhances your tax liability, over investing unnecessarily compromises your financial liquidity by blocking your finances in investments having longer lock-ins when same non tax saving options may be available without any lock-in.

       Compare the tax liability as per new and old tax regime

In the 2020 budget, a new tax regime was introduced with reduced tax rates to lower your tax liability if you are one of those who fail to get various deductions and exemptions as per the old tax regime. While the new tax regime is supposed to be beneficial if you have low investments by offering 7 lower tax slabs, it makes you forgo various exemptions and deductions that are otherwise available in the old tax regime. As the new tax regime is an optional choice, you can carry on with the old regime if it offers maximum benefit to you.

To know the best regime for yourself, use the online tax calculator, which would calculate your tax liability under both the tax regimes and afterwards you can choose the one with the lowest tax liability.

       Avoid just considering fixed income investments for your tax saving portfolio

Being conservative in nature generally makes you avoid investing in equity linked investments like ELSS mutual funds, NPS or unit linked insurance plans (ULIPs) even if such options provide higher returns as compared to the fixed income tax saving products like voluntary provident fund (VPF), public provident fund (PPF), national savings certificate (NSC) etc. over a long period. As equities generally beat inflation and fixed income investments over long term by a wide margin, equity linked plans in ULIPs, NPS, and ELSS funds under equity mutual fund category hold the potential to form bigger corpuses to meet your long-term financial goals.

Additionally, ELSS mutual funds come with a lock-in period of 3 years, which is one of the lowest amongst all tax saving options. This option also offers a higher level of liquidity than the fixed income tax saving options. Thus, you must carefully factor in your risk tolerance level, asset allocation strategy and investment horizon to choose your tax saving instrument accordingly.

       Avoid mixing insurance with investments

Many often tend to make the error of mixing insurance with investment i.e., you make investments in moneyback or endowment policies, which not just leads to insufficient cover but even yields sub optimal returns. 

As the fundamental purpose of buying life insurance is to provide a replacement income to dependents in the situation of your unexpected death, you must opt for a policy that provides you with adequate cover to not just meet your dependents’ daily expenses but also their crucial financial goals. Ideally, it is recommended to opt for a policy cover, which is at least 15 times of your annual income. One of the prudent ways to purchase such huge life covers at low premiums is by opting for term insurance policy. In consideration to long term wealth formation, you may choose ELSS funds as these provide higher liquidity and wide range of schemes to choose from as per your investment philosophies and risk tolerance level. 

Ending note

As finance is a personal affair, the same plan may not work for all, which means tax saving plans differ based upon your risk tolerance, asset allocation strategy and financial goals. Thus, when you select any tax saving instrument, you must ensure it matches with your risk tolerance and financial plans. By doing so, you not just enhance your chances of attaining your financial goals within the estimated time horizon but also lower your overall tax outgo.