Saving taxes this way can be injurious to financial health

January is a desperate time for the salaried class. Your employer must have given January 30 as the last date to file tax-saving investment proof for this financial year, or else February and March will see big cuts in salary to recover taxes. We invest in avenues that may save tax thanks to Section 80C but actually end up becoming poorer. Experts and advisors tell DNA Money how saving taxes in certain ways can be injurious to your health.

Don't be a Rhinoceroses

The majestic Rhinoceroses is most well-known for its impressive horns, and it’s often depicted charging targets with incredible speed. Even though rhinos can charge up to 30 miles per hour, they can’t distinguish between a human and a tree at 15 feet, so poor is their vision. Short-sightedness is the root of almost all investment-decision blunders by humans today.

Anand Dalmia, co-founder, Fisdom.com, says, "As January begins and HR departments ask for 80C investment proofs, almost involuntarily you dial your insurance-agent relative who has already promised you the moon through a ‘magical’ product with a fancier name. And like each year, once again, you bite the bait. Unit-linked insurance plans are a mix of insurance and an investment into market-linked units leading to a compromise on both fronts. With a lock-in of five years and returns anywhere in the ballpark of 5%-6%, this is far from a prudent financial decision."

In a haste, many also decide to buy some traditional insurance policies, to save tax. Amar Pandit, founder & chief happiness officer, HappynessFactory.in, says: "Little do people know that traditional insurance plans yield barely 4-5% returns per annum. Considering inflation, this capital will erode over the long run. Considering a person who is still young and all his goals are long term, he should be investing in avenues that can yield him much higher post-tax returns."

In fact, insurance policies should not be mixed with investments at all. "One should always buy a pure term policy, to protect the family in case of an eventuality, and accumulate wealth through a pure form of investments like mutual funds," points out Pandit, a CFA.

Kuber's formula

We all know that Lord Kubera is the boss of wealth. In your hurry to save taxes, are you forgetting wealth creation? Naveen Kukreja, CEO & co-founder, Paisabazaar.com, thinks people who tend to invest at the fag end of the tax saving season have a higher probability of committing mistakes. As they are in a rush, saving tax becomes their sole objective while ignoring other important parameters like post-tax returns, lock-in period and their own risk appetite.

"This often leads them to make suboptimal choices in terms of post-tax returns and liquidity. For example, the current annualised yields of tax-saving bank fixed deposits range between 6% and 7.5%. For someone falling in the 30% tax-slab, his post-tax returns from tax-saving fixed deposits would range between 4.2% and 5.25%. After considering consumer price inflation (CPI), his real returns could be really low, if not negative. Other fixed-income tax saving options do not fare any better as their current interest rates range between 7.6–8.3% with their returns, barring PPF, taxable according to one’s tax slab," adds Kukreja.

Compared to these fixed income options, equity-linked savings schemes (ELSS) outperform them both in terms of post-tax returns and liquidity. ELSS has the lock-in period of just three years, lowest among all Section 80C items, while their returns and maturity proceeds are totally tax-free. As equities outperform other asset classes in the long run, ELSS funds are better placed to beat inflation by a wide margin for the time horizon of five years and above.

Under Section 80C, a deduction of Rs 150,000 can be claimed from your total income. In simple terms, you can reduce up to Rs 150,000 from your total taxable income through Section 80C. This deduction is allowed to an individual or an HUF. The Section 80C provides deduction on investment in PPF, employee’s share of PF contribution, NSCs, life insurance premium payment, children’s tuition fee, principal repayment of home loan, Investment in Sukanya Samridhi Account, Ulips, ELSS, sum paid to purchase deferred annuity, five-year deposit scheme and senior citizens savings scheme, according to Anil Rego, founder, Right Horizons.

THE PITFALLS

• Short-sightedness is the root of almost all investment-decision blunders by humans today.
   
• Don't ignore other important parameters like post-tax returns, lock-in period and their own risk appetite
   
• Traditional insurance plans yield barely 4-5% returns per annum. Considering inflation, this capital will erode over the long run