When you talk about financial planning, making good financial decisions is as important as avoiding bad ones. This applies to your decisions for saving taxes too. In this post, I will discuss some of the common mistakes investors commit during the tax–saving season.
Following are the tax-saving mistakes you will do well to avoid.
Act in haste
This applies not just to your tax-saving decisions but to any decision in general. Most stupid financial decisions are made when you purchase a product without understanding it properly.
You have time till March 31, 2015 to invest to save taxes. So, don’t act in haste. Understand the product properly before making a decision. Don’t rely exclusively on the sales pitch to gather information about a product. Salesmen highlight only the positive aspects of the products but don’t go into the associated risks. It is your duty to find out if the product is suited to your financial goals.
Do not invest just to save on taxes. The investment should also fit your overall scheme of things.
Give into the pressure from Relatives and Friends.
How many of us have purchased a useless life insurance plan just because we couldn’t say no to a distant relative or a friend? Almost everyone. Have you ever purchased clothes that you didn’t like? If you can say no to a shopkeeper, why can’t you say no to an insurance plan you don’t like?
And insurance plans are long term commitments. Once you purchase, you can’t get out without taking a huge hit. You must purchase only what you need to buy, not what the other person wants to sell. Learn to say NO.
Purchase Traditional Life Insurance plans
These are the kind of plans that our parents used to purchase from LIC. And LIC is not the only insurance company selling such plans. Even private insurers such as ICICI Prudential and HDFC Life sell such plans. You must stay away from traditional life insurance plans. These insurance plans provide low insurance cover and poor investment returns.
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A number of times, customers find it difficult to identify if they are purchasing a traditional life insurance plan. Here is a rule of thumb.
- You should get alarmed if the insurance plan offers investment benefits too.
- If the insurance product name has either of the keywords “Assured”, “Guaranteed”, “Suraksha”, “Endowment”, “Savings” or “Moneyback” , you are most likely being pitched a traditional life insurance plan.
Term life insurance is the cheapest and the best form of life insurance.
Purchase Unit Linked Insurance Plans
Though not as bad as traditional life insurance plans, the Unit linked insurance plans (ULIPs) should still be avoided. If you go with these plans, you run the risk of being under-insured. You are much better off with combination of Term plan and mutual funds.
Entire Life Insurance Premium is eligible for tax benefit under Section 80C
This is a common misconception among investors. Annual premium is eligible for tax deduction only up to 10% of Sum Assured. This can be a problem with investment and insurance combo products, especially single premium life insurance plans.
That insurance plans make for bad investment products is known to most investors. You still rush into such products just to save on taxes. However, in this case, you may not even get the desired tax savings.
Visit a bank branch for tax-saving advice
Though it is unfair on my part to paint everyone with the same brush, you are better off seeking financial advice from your worst enemy than taking financial advice at a bank. At least, you will know what you are getting into.
Banks will deceive you. If you visit the bank branch for opening a plan vanilla 5-year tax saving fixed deposit, they will sell you a product that offers you better returns and insurance benefits too. Essentially, they will sell you insurance and investment combo product. They earn hefty commissions. And they don’t care a bit about you or your financial goals.
Forget about your EPF contribution, home loan repayment etc.
Your own contribution to your EPF account is also eligible for deduction under Section 80C of the Income Tax Act. Similarly, principal repayment of housing loan or tuition fees towards two children is also eligible for tax benefit under Section 80C. So, you need to plan only for the remaining amount.
Though it is not a sin if you end up investing more than Rs 1.5 lacs during a financial year, awareness will certainly help you plan your finances better.
Focus only on Section 80C tax benefits
Premium paid for health insurance plans or expenses incurred for regular health checkups is eligible for tax deduction under Section 80D of the Income Tax Act. In my opinion, an adequate health cover and regular checkups are equally important to your long term financial well-being. After all, health is wealth.
Interest payment on a house up to Rs 2 lacs (self-occupied house) per financial year is eligible for deduction under Section 24 of the Income Tax Act.
So, do not get fixated with 80C products for saving taxes. There are other saving avenues too which might fit your financial requirements better.
Know the rules well
Tax benefit for principal repayment or interest payment on a housing loan is eligible for tax benefit only after you receive possession of the house or the construction is complete. If you claim such tax benefit before possession and your case comes up for scrutiny, be prepared for a shock.
Similarly, investment in PPF account in excess of Rs 1.5 lacs (in your account or accounts where you are the guardian) won’t earn any interest.
In one of the earlier points, I discussed how entire life insurance premium is not tax deductible. So, you need to aware of these rules before you make the final decision.
Tax consideration shall not be the sole criterion behind your investment decisions. I would rather leave my Section 80C limit (or any other limit) unutilized than purchase financial products that are not suited to meet my financial goals. Avoid these common mistakes that investors commit during tax-saving season. You don’t have to be a finance expert to avoid these traps or mistakes. A little bit of information and discipline will do.
What do you think?
Image Credit: Chris and Karen Highland, 2015. The original image and information about usage rights can be downloaded from Flickr.