Which is the best Tax-Saving product?

Financial year is drawing to a close. In a few weeks (or perhaps months), tax-payers will start scrambling for the tax-saving investments. You have already made declaration to your employer that you will be investing (or purchasing) certain amount in specific tax-saving products. Now is the time to meet that commitment. What should you do? Which is the best tax-saving product?

There are many ways to save tax. You have an entire 80C product basket (PPF, EPF, NPS, ELSS, Insurance, principal repayment on home loan etc). You get tax benefits for purchasing health insurance (Section 80D). There is tax benefit for payment of interest on home loan (Section 24). There is additional tax benefit for investment up to Rs 50,000 in NPS (Section 80CCD (1B)). There are many more ways.  I do not want to get into all the ways possible.

If you are looking for an objective answer for the best tax-saving product, read no further. You are going to be disappointed. I do not intend to go into pros and cons of these products. I merely want to write about how should think about your tax-saving investments.

Let’s look at the advice you are going to get if you rely on others for this information.

What advice you are expected to get?

Depends on who you are asking:

1. If you ask a life insurance agent, 75% of the time you will be asked to purchase traditional insurance plans. Remaining will vouch for Unit Linked Insurance Plans (ULIPs). No one will speak of a Term Insurance plan, which is the best way of purchasing life insurance. Life Insurance companies are not far behind. No matter what you call them for, their representatives will talk about traditional insurance plans and ULIPs only.
2. If you ask a mutual fund distributor, you will be asked to purchase Equity linked savings scheme (ELSS or tax-saving mutual funds).
3. If you ask a health insurer, you will be pushed health insurance plans.
4. If you ask your parents, they will probably ask you to purchase a house and claim deduction for principal repayments and interest payments. Public Provident Fund and Fixed deposits will be one of their preferred options.
5. If you ask a perfectionist financial planner who wants to save every penny of tax, he/she will ask you to invest that extra Rs 50,000 in NPS

It is quite clear if you are going to rely on advice of others, there is bound to be a lot of confusion. Apart from financial planner and family, everybody else is likely to suggest products that suit them (and not you). It is not that those products will be bad for you. It is just that your interests took backseat when these products were recommended.

What is the best tax-saving product?

The fault lies with the question. The correct question is “What is the best tax-saving product for Me?”

So, the answer depends on you. Remember Personal Finance is personal.

There is no tax-saving product that is the best for everyone. It depends on your financial goals, circumstances and requirements. What might be a perfect product for me may not suit you.

For a 25 year old (with little financial responsibility and no short term goals), ELSS is a very good product.

For a single earning household (spouse and two young children) with little savings, adequate life insurance is a must. Term insurance is the way to go.

For a 60-year old retired person, there is not much use for insurance. There is greater need for regular income. Perhaps, senior citizen savings scheme is the way to go.

For everyone who has no health cover (or little health insurance cover), adequate health insurance cover is a must.

You can see there is no fixed answer. It simply depends on your life stage, financial goals and specific circumstances. Even for the life stages I have discussed, there might be cases where my suggestions won’t fit. So, you need to find out what suits you the best.

And it is not that you have to pick just one product. You can pick a few of them. Some part can go towards term insurance and health insurance premium. Remaining can go to ELSS or any debt product.

What I would suggest?

Wealth accumulation and wealth preservation are equally important. Pay attention to both.

Adequate life and health insurance is a must. Give it the topmost priority. Life insurance will bridge the gap between your net worth and the amount needed to meet your financial responsibilities and goals. Health insurance ensures quality health care for you and your family. About health insurance, if you think you cannot afford the premium, just think how you will afford the actual treatment.

Once you have taken care of your insurance needs, start working on wealth accumulation part. Get the asset allocation right.  You can choose among ELSS, PPF, EPF, NPS, SCSS etc based on your risk appetite, investment horizon, financial goals and preferences.

Suitability of the investment products cannot be discussed in this short post. Do that on your own or seek professional help.

A Few Points to note

1. Start early. Do not act in haste. You make the worst financial decisions when you purchase a product without understanding it properly. So, do not wait till March to start thinking about tax-savings products. Start right now. Give yourself time to understand terms and conditions and suitability of the product better.
2. Do look out for potential conflicts of interest. If someone benefits from your investing in product X (and not product Y) and recommends you product X, then your interest is not the priority.
3. Exercise discretion. Even the most unbiased advice is biased. And I am not just talking about agents/distributors who earn commissions on sale of products. Even the fee-only financial planners and SEBI registered Investment Advisers will have their biases. Though they will recommend products that are best suited to meet your financial goals, their advice may have still some element of bias. For instance, in my case, I am biased towards certain AMCs (mutual fund houses) and recommend funds mostly from those fund houses. It is merely a preference (and not that I get commission from those fund houses). However, I make it a point to make such disclosures to my clients. Seek proper rationale behind advice and always question them.
4. Do not invest just to save on taxes. Have the bigger picture in mind. Invest in a way that helps you meet your financial goals. Tax benefits are merely an added incentive. Traditional life insurance plans are the perfect example. These plans can help you save taxes but take your portfolio nowhere subsequently. Low insurance cover and poor returns.  Moreover, insurance products require long term commitment. Once you purchase, you will be reminded of your mistake for many years.
5. Don’t get fixated with lock-in period. All tax-saving products have a lock-in period attached. ELSS has the least lock-in period of 3 years. However, then you do not invest in equity funds if your goal horizon is 3 years.
6. Don’t score self goals. Avoid useless products such as traditional life insurance plans. These products provide low life cover and poor returns and should be strictly avoided.
7. Do not rely too much on others. I am not saying that you should not take professional advice. However, spend some time on educating yourself about financial products. And you do not need to spend much time either. An hour or so of reading every week about personal finance (n newspapers or websites) will do you a world of good. If nothing more, you will be able to ask the right kind of questions to the advisers. And yes, you wouldn’t score self goals.

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